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THE VALLEY BUSINESS JOURNAL 14 March 2018 Shareholder-Employee of an S Corporation: Are You Paying Yourself Reasonable Compensation? FINANCIAL by Esther Phahla, CPA, CTC, MST An S corporation is a corporation that elects to pass its corporate income, losses, deductions and credits through to its shareholder(s). A shareholder of an S corporation reports the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. When a corporate officer performs services for the S corporation and receives or is entitled to receive payments, their compensation is generally considered wages. Does it mean the corporate officer is an employee? Who is an employee of the S corporation?: The IRS states specifically that corporate officers are employees and that companies must comply with all employment laws in relation to these employees, including: 1) Paying payroll taxes on their salaries and withholding federal and state income tax from these salaries; 2) Paying unemployment taxes and workers compensation taxes on the salaries. The fact that an officer is also a shareholder does not change the requirement that payments to the corporate officer be treated as wages. The IRS requires that all shareholders of S corporations who perform services for their company pay themselves Reasonable Compensation, and it should be paid prior to taking any distributions. S corporation shareholders don’t pay self-employment taxes (Social Security and Medicare) on their distribution from the business. Because S corporation income is not subject to self-employment tax, there is tremendous motivation for shareholder-employees to minimize their salary in favor of distributions. S corporations should not attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses or loans rather than wages. The IRS has began taking aim at taxpayers who abused the employment tax advantage of S corporations by minimizing salary. Shareholder-employees who opted to forgo salary in favor of distributions, have found themselves in a situation where the courts have recharacterized the distributions as compensation under the principle that any employee who renders significant services to an employer must be paid “reasonable compensation.” What is Reasonable Compensation? Reasonable Compensation is defined by the IRS as “The value that would ordinarily be paid for like services by like enterprises under like circumstances”. Therefore, it is the salary or wages that you, the shareholder-employee of an S Corp, pay yourself for the work you perform for your company. Some factors considered by the courts in determining reasonable compensation are: • Training and experience • Duties and responsibilities • Time and effort devoted to the business • Dividend history • Payments to non-shareholder employees • Timing and manner of paying bonuses to key people • What comparable businesses pay for similar services • Compensation agreements • The use of a formula to determine compensation Another way to determine a reasonable salary for corporate officers is to look at what other companies of similar size and type pay for such services. As a shareholder employee, the key to establishing reasonable compensation is determining what you do for your S corporation. You might be doing more than just generating revenue for your business, you are probably also involved in administrative work. It is important that you research and document how you reach your Reasonable Compensation amount and be able to substantiate the salaries you are paying, that will help keep you on the right side of the IRS when it comes time for them to review your company’s tax returns. The best time to establish your Reasonable Compensation amount is before an IRS examination. You don’t have to figure out Reasonable Compensation on your own. There’s help. The issue of Reasonable Compensation and wages will play a bigger role starting in 2018 with regards to the new 20% Qualified Business Income deduction for flow through entities, from the Tax Cuts and Jobs Act of 2017. Reminder tax deadline: S corporations and partnerships are due March 15, 2018 (that follow the calendar year). If you need additional time to gather your tax information your extended due date will be September 17, 2018. Esther Phahla is a Certified Public Accountant and Certified Tax Coach in Temecula. She is the Best- Selling Co-Author of a tax planning book “Why Didn’t My CPA Tell Me That”. She also holds a Master’s of Science in Taxation. She can be reached at (951) 514-2652 or visit

March 2018 THE VALLEY BUSINESS JOURNAL 15 Southwest Healthcare System Recognized CONTINUED FROM PAGE 1 Blue Cross and Blue Shield has recognized Southwest Healthcare System’s Rancho Springs Medical Center with a Blue Distinction® Center for Maternity Care designation as part of the Blue Distinction Specialty Care program. Blue Distinction Centers are nationally designated hospitals that show expertise in delivering improved patient safety and better health outcomes, based on objective measures that were developed with input from the medical community. Nearly four million babies are born in the U.S. annually, making childbirth the most common cause of hospitalization, and cesarean sections the most common operating room procedures, according to National Centers for Health Statistics and the Agency for Healthcare Research & Quality (AHRQ). Reducing early elective delivery is an area of focus for the American College of Obstetricians and Gynecologists (ACOG) and the American Academy of Pediatrics (AAP). According to Health Affairs, elective inductions result in more cesarean deliveries and a longer maternal hospitalization. The Blue Distinction Centers for Maternity Care program evaluates hospitals on quality measures for vaginal and cesarean delivery. Rancho Springs Medical Center is proud to be recognized by Blue Cross and Blue Shield for meeting the rigorous Blue Distinction Center quality selection criteria for maternity care set by the Blue Distinction Specialty Care program. “This award is a reflection of the high quality of maternity service that our staff has displayed,” says Brad Neet, CEO of Southwest Healthcare System. “We strive each and every day to make the patient experience a top priority and it shows by our level of commitment.” Since 2006, the Blue Distinction Specialty Care program has helped patients find quality specialty care in the areas of bariatric surgery, cancer care, cardiac care, maternity care, knee and hip replacements, spine surgery and transplants, while encouraging health care professionals to improve the care they deliver. Research shows that, compared to other hospitals, those designated as Blue Distinction Centers demonstrate better quality and improved outcomes for patients. For more information about the program and for a complete listing of the designated facilities, please visit www. Inland Valley Medical Center is the only hospital in the region to offer Level II Trauma Services, the region’s only Total Joint Center and is a nationally recognized center for weight-loss surgery by the Metabolic and Bariatric Surgery Accreditation and Quality Improvement Program. Rancho Springs Medical Center features the largest Women’s Center in the region which includes the Rady Children’s Neonatal Intensive Care Unit (Rady San Diego: Ranked 5th in the nation for neonatal care) and the da Vinci © Robotic Surgical System performing the region’s first virtually no-scar single site procedures. About Blue Cross Blue Shield Association - The Blue Cross and Blue Shield Association is a national federation of 36 independent, community-based and locally operated Blue Cross and Blue Shield companies that collectively provide health care coverage for one in three Americans. BCBSA provides health care insights through The Health of America Report series and the national BCBS Health Index. For more information on BCBSA and its member companies, please visit We also encourage you to connect with us on Facebook, check out our videos on YouTube, follow us on Twitter and check out our blog. About Blue Distinction Centers - Blue Distinction Centers (BDC) met overall quality measures for patient safety and outcomes, developed with input from the medical community. A Local Blue Plan may require additional criteria for providers located in its own service area; for details, contact your Local Blue Plan. Blue Distinction Centers+ (BDC+) also met cost measures that address consumers’ need for affordable health care. Each provider’s cost of care is evaluated using data from its Local Blue Plan. Providers in CA, ID, NY, PA, and WA may lie in two Local Blue Plans’ areas, resulting in two evaluations for cost of care; and their own Local Blue Plans decide whether one or both cost of care evaluation(s) must meet BDC+ national criteria. National criteria for BDC and BDC+ are displayed on Individual outcomes may vary. For details on a provider’s in-network status or your own policy’s coverage, contact your Local Blue Plan and ask your provider before making an appointment. Neither Blue Cross and Blue Shield Association nor any Blue Plans are responsible for non-covered charges or other losses or damages resulting from Blue Distinction or other provider finder information or care received from Blue Distinction or other providers. “ The most significant part of the new tax law is the reduction in corporate tax rates from 35% to 21% “Would you like me to give you a formula for success? It’s quite simple, really: Double your rate of failure. You are thinking of failure as the enemy of success. But it isn’t at all. You can be discouraged by failure or you can learn from it, so go ahead and make mistakes. Make all you can. Because remember that’s where you will find success.” ~ Thomas J. Watson