The Requirement for S-Corporation Compensation Reporting

Subchapter S corporations, also known as S-Corporations, are unique in their tax treatment. One of the key requirements is that any officer of the corporation must be paid a 'reasonable compensation' for their services and treated as an employee of the company. This obligation extends beyond just compensation; it also includes withholding FICA, Medicare, and other employment taxes from the officer’s pay and paying your share of these taxes as the employer. At the end of the year, the officer receives a Form W-2 and a Form K-1 if the company has made a profit. The company then files on Schedule E and is subject to income tax but not self-employment taxes.

Why Use Form W-2?

As an independent tax professional, my preferred approach is to assist clients with S-Corp structures. I charge a monthly fee for handling payroll and monthly accounting, and at year-end, I assist with both the business and personal tax returns. Even with these fees, a successful S-Corp structure can save the owner around $4,000 to $5,000 in self-employment taxes (Form Schedule SE).

The Necessity of a Corporate Tax Return

While S-Corporation owners generally do not pay self-employment taxes, they are still required to file a corporate tax return (Form 1120S). This return shows the company's profits after deducting the officer's salary and other company expenses. The company does not pay taxes on the profits; instead, the profits are distributed to the owner through Form K-1. The owner then includes this income, along with the salary paid, on their personal income tax return (Form 1040).

Understanding Form W-2 and Its Role

Form W-2 is used to report an employee's annual wages, tips, other compensation, and the taxes withheld from those earnings. It is an essential document for both the employee and the employer. The employee uses this form to report their income and salary for the tax year and to file their personal income tax return. The employer uses Form W-2 to report employment taxes and to file state and federal employment tax returns.

Form Schedule SE: A Self-Employment Tax Alternative

Form Schedule SE, also known as the Self-Employment Tax, is used by individuals who operate as sole proprietors or have self-employment income. However, this form is not typically used by S-Corporation owners if they are properly following the requirements of the S-Corporation structure. Instead, S-Corporation owners should rely on Forms W-2 and 1120S for tax reporting.

Conclusion

In conclusion, for S-Corporation owners, it is crucial to understand the proper reporting of compensation and wages. Using Forms W-2 and W-2C ensures accurate income and employment tax reporting. While it is possible to avoid self-employment taxes (Form Schedule SE) through the proper structure, it is essential to maintain the terms of the S-Corporation to avoid any tax compliance issues or penalties. Consulting with a tax professional can help ensure that all requirements are met and that the S-Corporation structure is used to its full advantage.