Chapter 13 - § 13.1 • CORPORATE EMPLOYEES

• Jurisdiction: Colorado

§ 13.1 • CORPORATE EMPLOYEES

§ 13.1.1—Corporate Employees — General

Salaries paid by a corporation are subject to employment taxes that are required under the Federal Insurance Contributions Act (FICA). FICA consists of two separate taxes: the Social Security tax and the Medicare tax. For 2019, the employee pays 7.65 percent on the first $132,900 (both taxes combined) and 1.45 percent (the Medicare tax) on any excess. The corporation must pay a corresponding amount.¹

The Patient Protection and Affordable Care Act (PPACA), as amended by the Health Care and Education Reconciliation Act, provides that individuals who have in excess of $250,000 of wages (joint return filers; $125,000 for married taxpayers filing separate returns; $200,000 for other taxpayers) will owe an extra 0.9 percent hospital insurance (HI) tax.² Although the employer is not liable for the extra HI tax, an employer is required to withhold the extra HI tax from the wages of a taxpayer who receives more than $200,000 in wages from the employer.³

In addition, a federal unemployment tax of 6.2 percent applies to the first $7,000 per year of "wages."⁴

§ 13.1.2—Employee Shareholders of S Corporations

In an S corporation, salary paid to an owner-employee is subject to FICA and to the other taxes discussed in § 13.1.1. Any profits of the S corporation allocated to the owner-employee over and above the owner's salary are not subject to FICA. Conversely, in most situations (although the IRS has not issued final guidance), all of the net amount allocated to an LLC member may be subject to SECA (the self-employment version of FICA), and an LLC does not have the option to subdivide those allocations between salary and allocations not subject to self-employment tax.

This may lead to the temptation to make an S corporation election and allocate $1 per year to salary and take the balance as allocated profits. Such an action will spark IRS interest and likely lead to a reallocation of the split away from an overly aggressive position of the taxpayer. For example, in David E. Watson, P.C. v. United States,⁵ the court considered a case in which a professional shareholder in an S corporation was paid a "salary" of $24,000 per year and received "distributions" of $118,159 in 2002 and $221,577 in 2003. At trial, the IRS established that the reasonable amount of remuneration for Watson's services in both 2002 and 2003 was $91,044, or $67,044 more than Watson reported.⁶ Thus, even after the IRS adjustments...