S corporation owner pay: reasonable compensation and health insurance records

A shareholder who works in an S corporation is an employee, and the IRS expects them to receive reasonable pay for the services they provide before profit is distributed. There is no formula. Duties, time worked, training, and what others are paid for similar work in the same area all bear on it.

Write a short memo each year with the shareholder's role and duties, hours, the figure chosen, and the basis: salary surveys, job postings, or a professional's opinion. Update it when duties change. Keep the payroll records that show it was paid through payroll, with withholding. If the IRS asks, the memo is the starting point of your answer.

For shareholders who own more than two percent of the stock, health insurance premiums paid by the company are generally treated as wages for income tax, included in the W-2, and then deductible by the shareholder on their personal return, subject to conditions. Social Security and Medicare tax treatment depends on the plan. The IRS has specific guidance, so confirm it with your payroll provider and preparer.

The failure mode is that premiums are paid by the company but never added to the W-2, which creates a mismatch discovered later. Make the payroll setup match.

Business expenses a shareholder pays personally should be reimbursed under an accountable plan, with receipts and a business purpose. That keeps the reimbursement out of wages. Unreimbursed expenses, or reimbursements without records, can be recharacterized.

Review compensation each year before the last payroll, since changing it in December is easier than explaining it in April. Compare pay to profit, and confirm distributions are in proportion to ownership.

A short memo is enough if it is specific. It names the shareholder and the role, lists the main duties and the hours worked in a typical week, and states the pay chosen for the year. It then gives the evidence: two or three salary survey results for similar roles in the region, or a note from the company's accountant. It is dated, and it is updated when the job changes. If the owner starts managing more people or takes on a second role, the pay should be revisited and the memo should say so.

An S corporation pays $9,000 a year in health insurance premiums for its owner, who holds 50 percent of the shares. Payroll adds the $9,000 to the owner's taxable wages on the W-2. The owner then claims the self-employed health insurance deduction on the personal return, subject to its limits. If payroll never adds the premiums, the deduction does not line up with the W-2, and the mismatch tends to surface as a notice. Set the premium up as a taxable benefit in the first payroll after the plan starts.