S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level.
To qualify for S corporation status, the corporation must meet the following requirements:
Be a domestic corporation
Have only allowable shareholders
May be individuals, certain trusts, and estates and
May not be partnerships, corporations or non-resident alien shareholders
Have no more than 100 shareholders
Have only one class of stock
Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).
S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly.
The instructions to the Form 1120-S, U.S. Income Tax Return for an S Corporation, state “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.”
The IRS has the authority to reclassify payments made to shareholders from non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes). Several court cases support the authority of the IRS to reclassify other forms of payments to a shareholder-employee as a wage expense which are subject to employment taxes.
When computing compensation for employees and shareholders, S corporations may run into a variety of issues. The information below may help to clarify some of these concerns.
- Reasonable Compensation
- Treating Medical Insurance Premiums as Wages
- Health Insurance Purchased in Name of Shareholder
- ACA Impact
- Notice 2015-17 Transition Relief
- Fewer Than Two Participants Who Are Current Employees Exception
- Qualified Small Employer Health Reimbursement Arrangements for Eligible Small Employers (QSEHRAs)
- Limitations on QSEHRA participation for 2-percent S Corporation shareholder-employees
- QSEHRA Notice Requirements
- Failure to Satisfy the Requirements to be a QSEHRA
- Interaction with HSA Requirements
- Notice 2017-67
- Health Reimbursement Arrangements and other account-based group health plans