S-Corporation Compensation vs. Flow-Through Income

[Ben Skove]

After meeting with my CPA today, and going through a number of back posts from the BP forums, I'm interested in hearing more about how the IRS oversees the balance between S-Corporation compensation versus flow-through shareholder income.

Perusing the IRS information, they state:

It seems to me that if you use a S-corp, pay yourself only a small salary, and are very actively involved in your flips, the IRS can step in and reclassify most of your pass-through as wages. My CPA didn't seem to think this was much of a problem, and stated that it was very seldom that he'd seen this occur. I'd much rather be conservative and avoid potential (and costly) pitfalls down the road.

While the rule seems to be plain, I'd like to know how it's actually implemented in real life. Has anyone had this happen to them?

[J Scott]

My CPA is pretty middle-of-the-road when it comes to these things (not to conservative and not too aggressive). For the past 5 years, he's told me (and I've listened) to pay myself about 40% of my income as salary and take the rest as distributions. He believed that 40% (given the 6-figure income) was considered "reasonable salary."

This year, he's telling me to up that salary percentage to 60% of income. He says that the IRS is getting tougher in their rulings, and that 60% is probably better to avoid audit and negative audit determinations.

So, I'm now paying myself 60% of my income as salary and 40% as distribution.

Please don't construe this as advice on what you should do...I'm just relaying what my CPA is telling me and what I'm doing...