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May an S Corp (with revenue) defer any kind of salary or distribution in its first year, if the S-corp had only recently been formed in the last quarter? If for example, it would be more beneficial to pay them the next year, or to use its revenue to build the business, and forgo distributions or salaries initially?

2 Answers 2

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This is perfectly fine. I don't know of any rule that you must pay the S-Corp owners, ever. AFAIK the rule about taking a reasonable salary only applies if you decide to distribute profits to the owners.

As a rule of thumb:

Consider paying the owners between $0 and a reasonable salary (W2) each year. In years that you have reached a reasonable salary, you can also take distributions that year.*

Note, generally, you must pay your employees who are not owners.


* Achieving a "reasonable" salary prior to any distributions may be overly conservative. For example, suppose a reasonable salary is $75K, yet you only had enough profit one year to pay $60K in salary. IMHO taking a $50K salary with $11K in distributions probably won't raise any flags, and in theory you'd save over $1K in FICA taxes. However, that breaks my rule of thumb, and therefore I probably wouldn't personally recommend it, if you asked me.

Also, another related thing you can't do is take zero salary for years, save up all of the profits, and then one year take a $150K salary and distribute millions on top of that. This would be obvious tax evasion.

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  • Thanks for this well thought out answer @TTT, appreciate it. Your thought process seems the most viable, I’m not sure the other short answer here is considering the whole question
    – number41
    Commented Dec 30, 2022 at 21:47
  • @number41 make sure you understand this answer. TTT and I are saying the same thing, in different words. If your corp has profits - reasonable salary should be paid. See the comments under my answer. For SCorp profits are always distributed, you cannot have retained earnings in an SCorp.
    – littleadv
    Commented Dec 30, 2022 at 21:50
  • @littleadv I agree that S-Corp profits are "distributed", or perhaps "accounted" for tax purposes, but that doesn't mean any money is necessarily paid to the owners. If no money is paid then you would have retained earnings. (Not sure why you say you can't?) When money is actually paid out based on the number of shares you own, a C-Corp calls it "dividends" and an S-Corp calls it "distributions". The difference is distributions are not a taxable event, unless you distribute more than your profits + stock basis. (In which case you pay capital gains on it.)
    – TTT
    Commented Dec 31, 2022 at 7:02
  • @TTT no, if no money is distributed you would not have retained earnings, you would have adjusted basis. Essentially the owners reinvested the profits attributed to them. "Retained earnings" is a well defined term. They're only allowed to accumulate for corporation taxed under subchapter C
    – littleadv
    Commented Dec 31, 2022 at 7:48
  • @TTT the point that the OP is trying to work around is that SCorp profits are taxable in the year made. If the corporation is profitable - reasonable salary must be made. Whether the owners reinvest the profits or withdraw them is irrelevant because distribution of profits is not a taxable event. For C corps dividend is a taxable event, so there's a meaning to "retained earnings" - profits that were taxed at the Corp level, but not at the owners' individual level.
    – littleadv
    Commented Dec 31, 2022 at 8:04
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If the SCorp is profitable, the IRS will expect a reasonable salary to be paid.

Distributions are your own business and noone cares about them, the money will be taxed either way.

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  • Interesting. Our answers conflict with each other. Right now I'm leaning towards you're probably right and I'm wrong. Do you have a source for this?
    – TTT
    Commented Dec 30, 2022 at 18:22
  • After further thought I think it's possible we're both correct. If you don't take distributions you don't have to take a salary, but you also can't abuse it by saving up profits over multiple years and then distributing them all at once after paying a reasonable salary. (See the footnote of my answer for details.)
    – TTT
    Commented Dec 30, 2022 at 18:31
  • @TTT distributions is a meaningless term in the context of SCorp. The requirement for reasonable salary comes from tax law perspective to reduce tax evasion (after all, SCorp is a tax avoidance tool), so it only kicks in if there are profits. The reasonable salary requirements is the same for any corporation, but they're enforced differently depending on the subchapter treatment. For C it kicks in for losses, for S it kicks in for profits.
    – littleadv
    Commented Dec 30, 2022 at 21:47

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