POINTS AND AUTHORITIES – SELF-EMPLOYMENT TAX AND S CORPORATION OWNERS
I. Shareholders of S Corporations Are Not Considered Self-Employed for SE Tax Purposes
Point
S corporation shareholders, even if they are owner-operators or provide services to the business, are not treated as self-employed for purposes of self-employment tax on their share of the business’s income.
Authorities
- 26 U.S.C. § 1402(a)(2) –
Specifically excludes “distributive share of any item of income or loss of an S corporation” from net earnings from self-employment. - IRS Publication 334 – Tax Guide for Small Business “If you are a shareholder in an S corporation, your share of the corporation’s income is not self-employment income.”
- IRS Instructions for Schedule SE (Form 1040) –
States that S corporation income is not subject to self-employment tax.
II. S Corporation Owners Who Provide Services Must Be Paid Reasonable Compensation as Employees
Point
An S corp owner who performs substantial services must be paid a reasonable salary as a W-2 employee. That salary is subject to employment taxes (Social Security, Medicare), but not self-employment tax.
Authorities
- Rev. Rul. 59-221, 1959-1 C.B. 225 –
The IRS ruled that compensation for services of shareholder-employees must be treated as wages. - IRS Fact Sheet FS-2008-25 – Wage Compensation for S Corporation Officers “S corporation officers who provide more than minor services to the corporation and receive or are entitled to receive payment are considered employees.”
- Treas. Reg. § 31.3121(d)-1(b) –
Defines officers of a corporation who perform services as employees.
III. Only Wages Paid Are Subject to Payroll Taxes; Distributions Are Not
Point
Only the wages paid to the shareholder-employee are subject to FICA taxes (Social Security and Medicare). The remaining profit distributions are not subject to self-employment tax or FICA, assuming reasonable compensation has been paid.
Authorities
- IRS Form 1120-S Instructions –
Explains the distinction between wages (reported on Form W-2) and distributions (reported on Schedule K-1). - IRS CCA 2003-026 –
Advises that reasonable compensation must be determined and paid before any distributions to avoid tax avoidance.
Conclusion:
An S corporation owner is not considered self-employed for purposes of self-employment tax on profits. Instead:
- They must take a salary subject to payroll taxes (FICA),
- Distributions beyond reasonable salary are not subject to self-employment tax.