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Compensation Issues for S Corporation Owner-Employees: Wages or Profit Distributions?
Angela Hwang,
Eastern Michigan University
ABSTRACT. S-Corporation owners, who also provide service to the business as an employee, generally prefer receiving payments from the S-Corp as profit distributions to avoid 15.3% employment taxes on wage payments. However, higher wages may be beneficial. First, one receives greater retirement benefits by paying higher social security taxes on wages. Second, FICA tax paid by the S-Corp is tax-deductible. Third, higher wages permit higher tax-deferred retirement contributions. This paper uses a spreadsheet simulation to examine the impact on an S owner-employee’s overall tax burden by quantifying and considering both tax and economic factors on receiving wages from the S-Corp. The findings dispel the misconception that tax burden increases as wage payments increase for an S owner-employee. The results further show that one would suffer long-term economic losses when reporting lower wages and underpaying the social security tax since this translates to lower retirement benefits to be received.
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