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S corporation: distribution vs. salary

My husband & I own & operate a small S-corp in NJ. Our accountant cautioned us against taking distributions, indicating we should take $ from the company in the form of salary only. Considering the high amount of $ we pay for payroll taxes and that our salaries greatly increase the cost for our insurance (workmen's comp etc. insurance based on audits of our payroll records) we cannot figure out why she told us to take salary over distributions. The company is not making large profits each year where we'd need the tax break. Your help will be much appreciated!

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S- Corp Distributions

Hi,

First off, I'd check with NJ department of labor and see if there's a waiver for workers' comp insurance on owner-employees. In some states the you can request to exempt from worker's comp but usually there's some form you have to fill out.

I can't see your exact situation and your accountant can, so I'm a bit hesitant to over rule her. :)

That being said, there are three things you need to be concern with when taking distributions.

First, are you taking a reasonable salary? Based on your comments about the worker's comp, I'd guess yes.

Second, are you taking out more in distributions than you are in salary? If you're taking $20K in salary & 100K in distributions, then you have a problem. However, if it's the reverse, then probably not.

Third, do you have sufficient basis to make the distribution? If you don't have $20K in basis, you can't make the distribution.

Again, I don't know your exact situation. It would be interesting to hear the reasons your accountant gave you for her advice. The IRS is cracking down on S-Corp owners to take distributions in lieu of salary. It can reclassify those payments to salary and impose the employment taxes and penalties on those payments. That could be part of her reason.

The trick is to make sure you salary is reasonable. Unfortunately, there's no definition of what "reasonable" is. If you can find a salary survey that shows what you pay yourself is similar to others in your industry, you should be fine.

Hope this helps a little.
L:)

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