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                        These federal cases
have now been the backbone or blueprint to these issue regarding compensations
as wages. A shareholder who provides major services should be considered as
employees and receive wages. When reaching a reasonable wage, it should be
analyze by several factors such as what type of business, duties and
responsibilities and how much time is devoted to the business. Even if it is
not your intent to avoid paying payroll taxes, you must follow rules of the tax

these cases above, the S corporation had not reported any compensation.
However, in the case of DAVID E. WATSON, P.C. v. U.S., there was some sort of
wages paid but there was three times as much distributions being paid as well.
Therefore is the compensation reasonable, which is what the court had to figure
out. There was no debate that the shareholder officer was an employee. David
Watson was an accountant who was the sole shareholder director, officer and
employee of an s-corporation. He was 25 % partner in an accounting firm that
paid him an annual salary of $24,000. Along with his annual compensation, the
accounting firm made large profits of $24,000 and gave David Watson
distributions of $203,651 in 2002 and $175,470 in 2003. There was no income tax
withheld from these dividends. Therefore, the district court was forced to
quantify what is a reasonable compensation for Watson. So the IRS engaged the
services of a general engineer who used financial ratios to establish whether
his compensation was reasonable or unreasonable. As of result, the court upheld
the district court of an annual compensation of $93,000 from the distributions
he earned each year.

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                           In the case of Joly
vs. Commissioner, 211 F.3d 1269 (6th Cir., 2000), the court ruled him an
employee to the corporation.  “Tax court
found that these calculations were based on the corporation’s bank statements,
which indicated that regular payments were made to and on behalf of Joly” (Joly
vs. Commissioner, 211 F.3d 1269 (6th Cir., 2000)). He was actively
participating in the overall services in the business which leads the court to
hold him accountable for employment taxes not paid. Another case, that helps
justify whether payments should be classified as wages and not as
distributions. In reference to code section U.S. Code § 1368 – Distributions,
it is defined as ” A distribution of property made by an S corporation with
respect to its stock to which (but for this subsection) section 301(c) would
apply shall be treated in the manner provided in subsection (b) or (c),
whichever applies.” In this case, Joseph M. Grey Public Accountant, P.C. vs.
Commissioner, 119 T.C. 121 (2002), the accountant was taking dividends and
instead of paychecks as an employee. When taking dividends this only affects
their basis in the s corporation and thus are not taxed as wages avoid paying
social security and Medicare tax.


                                 In reference
an accounting firm that paid dividends but no compensation who provided
services to the corporation. SAI was owned by a Spicer who was a CPA and his
spouse and he worked approximately 36 hours per week. He was the only
accountant for his company. He would withdraw his earnings as distributions.
Therefore, he never paid payroll taxes on the amounts received. The ninth
Circuit look closely into what represented these distributions that were being
paid to him. So first they looked into what defines an employee for payroll tax
purposes, which include any officer of a corporation. However, as we discussed
early, it depends if there was major or minor services provided to the
corporation. Since he was the only accountant in his firm, he was the only one
able to provided tax return and audit services to clients. The ninth circuit
concluded that the distributions that were withdraw for Spicer was indeed
compensation and should be subjected to payroll taxes. Spicer, a full time
worker cannot avoid paying payroll tax or self-employment tax just because he
created an S corp. The correct method was to create a sole proprietor or
single-member LLC and pay self-employment tax if he was trying to avoid paying
payroll tax.


                      Now that we
understand what an S Corporation status represents and its purpose. Can
shareholders such as a corporate officer receive a w-2 and schedule k from the
same business. As a shareholder of an S Corporation, at the end of the tax
year, schedule k reporting the gross profit/ loss of the company will be sent
to each shareholder. However, if that shareholder perform a service for the
corporation and receive payments, those payments are considered wages according
to the internal revenue code. It doesn’t matter if it’s a corporate officer,
they are still considered an employee. There have been cases where courts have
held S corp officers/ shareholders who provide more than minor services to
their corporation and receive compensation are subject to federal employment
taxes. However if they provide only minor services, is not considered an
employee. Therefore, in some cases companies have tried to pay a reasonable
amount of wage to corporate officer but take a large amount of distributions.
Shareholder-employees wants to minimize compensation in favor of distributions
to reduce payroll taxes. Since employment tax obligation have risen, the
advantages in operating as an S-Corporation has been looked into closely. S
corp income are not subject to self-employment tax, more officers are in favor
to minimize salary and take distributions to avoid paying payroll tax nor
self-employment tax.


                     Can a shareholder of an
S-Corporation receive a w-2 and schedule-K? Before we answer this question, we
must take a few steps back and analyze an S-Corporation entirely.
S-Corporations is what we call a flow through entity. The reason we call this a
flow through entity because they pass corporate income, loss, deductions, and
credits through to their shareholders for federal tax purposes. Therefore, the
shareholders report income, loss, deductions and credits on their personal
income tax return and are assessed tax on their individual income tax rates.
Many investors are more subjected to elect into an S-corporation because it
avoids the hassle of a double taxation. What is double taxation? It simple
terms, it is paying tax twice for the same income. Business owners often try to
avoid paying tax, but paying tax twice just seems unfair. For example, a Corp is
taxed as its own entity. Profits are taxed at corporate income tax rates. There
is no problem with this. However, when a shareholder are paid dividends, these
dividends are taxed at a personal income tax rate. Therefore many small
businesses elect to change an S Corp status with the IRS, to avoid this double
taxation. Achieving S corporation status, a corporation must first qualify as a
small business corporation and met a few requirements that include if it’s a
domestic corporation, is an eligible corporation, issues only one class of
stock, limited to maximum of 100 shareholders, and has no nonresident alien
shareholders. Once achieved S corporation status, small business owners can
take advantage of the benefits for federal tax purposes.


S corporations are known to have
tax advantage and benefits when it comes to filing taxes. This is the result of
many small business electing to switch to an S corporation. Although, some
corporate officers can run into small problems when it comes to payments made
to themselves. Often time’s shareholders have agreements within the Corporation
that state their share will be the profits of the company. However, if you
provide major services to the corporation, these payments are most often time
considered wages. Base of a few federal court cases, we will see how these can
be justified and how IRS acts toward this misconception of payments.

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