By Garrett Sutton, Esq.
Have you ever wondered what the difference is between an S and C corporation? The advantage of an S corporation over a C corporation is the flow-through nature of the entity. (Know that an LLC can also be a flow-through entity and that an LP must be taxed in such a manner.) Profits are taxed not at the entity level but rather at the shareholder level.
One benefit of the S corporation has to do with Social Security withholding taxes. (In some situations they are called FICA taxes, in others self-employment taxes. Most of us, though, generally refer to these monies headed to our bankrupt Social Security system as ‘payroll taxes’.) Shareholders in an S corporation who take a salary can also take distribution of excess profits without paying payroll taxes.
However, the salary the shareholder receives must be reasonable. Too low a salary coupled with higher distributions of profits can signal to the IRS that a shareholder is avoiding paying the Social Security system its ‘fair’ share and trigger an audit. If the discrepancy between the low salary and the high amount of distributions is too great, the IRS may disallow the distribution and consider all monies received to be salary, with taxes to be owed on that amount (along with penalties and interest). So, make sure to pay yourself a reasonable salary and you can also enjoy your profit distributions through an S corp without paying payroll tax on the distributions themselves.