But one of my regular readers makes the following case:
Among other things, I’m sometimes a little bit of a tax lawyer.
A few things you ought to know:
S corporations whose shareholders also perform substantial services (“shareholder/employees”), such as Edwards, must pay those shareholder/employees “reasonable compensation.”
The only question is whether $600,000 a year in 1996 and $540,000 in 1997 is enough compensation, or should have been more.
You might ask, “But what stopped him from paying salaries or bonuses of, say, the whole $5 million in each of those years?” The answer is, if he characterized too much as salary, the excess could (should) be recharacterized for tax purposes back to exactly how he treated it — a dividend (or, more precisely, an S corporation distribution). There are restrictions on paying excess compensation built into the tax code.
So I ask you — how much should any “small businessman” take as an annual salary in a business that shows distributable profits in the $5 million range annually? More particularly, how much should any small businessman who is a trial lawyer take out of a legal business?
The real problem is that dividends are not “earned income” subject to FICA.