Drawing salary from S-corporation

[Dmitriy Fomichenko]

Looking for some feedback from tax experts. I'm asking this on behalf of a client. Client and a partner own an S-corporation. Client told me that they never took a salary from the corporation and simply take dividend distribution through K-1 which goes onto their personal tax return. 

It is my understanding that S-corporations must pay reasonable salary to shareholder-employees so I suggested that they speak with their tax preparer or consult with another CPA or accountant on this topic. I don't think they followed my advise so I wanted to ask this question of BP community. Can you provide some clarity on this subject. Reference IRS code, penalties or other consequences for not doing it, etc? Thanks!

[Brandon Hall]

@Dmitriy Fomichenko good of you to ask - your client should really seek help. It depends on how much profit is earned and what the client's participation in the business looks like.

The IRS expects S-Corp owners who work in the business to receive some sort of salary. Failing to pay salary means the S-Corp owner is not paying SE taxes at all, rather issuing him/herself dividends. This is called tax evasion and the IRS has an unlimited statute of limitations. 

The IRS is actively litigating S-Corp owners, even really small S-Corp owners. I've had several clients this year where I've gone back and reclassified portions of their distributions as salary. I don't want that blowing up in my face when the inevitable audit comes around.