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Comment by joe_bleau | Hacker News Reader

See, this points out something I've never understood. If you own an s-corp, you have to be careful about paying yourself too little and taking out too much profit, presumably due to the reduction in FICA withholdings.

So how does someone like Steve Jobs get away with making a $1 annual salary without being charged with tax evasion? It seems like he's found a way to avoid paying into the social security and workmen's comp system.

What am I missing? Is it only legal to dodge withholdings in a c-corp?

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There is some confusion there.

His $1 salary is exactly that. A token amount paid by Apple for his work. It cannot be $0, otherwise he wouldn't be considered an employee and wouldn't be entitled to bonuses, stock options, insurance, etc. The fact that he is taking a $1 and tying all of his income to options, bonuses, perks means that he firmly believes his impact to the company will be rewarded - and it has, rightfully so. By taking a $1 salary, you are saying to the shareholders (world) that you believe so firmly in the company, that, you'll earn your income the same way a shareholder would - through the growth in stock price, etc. He does have to pay taxes on personal use of the corporate jets, and other benefits. I can't really imagine his situation being so dire that any social security income he could get would have any material impact on his life. We also don't know what the nature of his contributions were years ago.

Paying too little and taking out too much profit is actually tied to a separate issue. If one runs an S-Corp and is in the typical feast and famine cycle, i.e lots of work, bill lots of money, work slows down, time for lots of sales because there is no work, here comes work again, then, the IRS could say that you took $x+y during the time when you were cash-flush, and $x when you were in your income slump, making $y a dividend and taxed as such. In many cases, dividend income is taxed at a higher rate than personal income until you hit a certain income (I believe $373k/year or so and in 2013, $171k or so). If you earn less than those amounts, dividends are taxed more heavily than normal income.

A C-corp is its own financial entity. It pays its own taxes, has a separate tax structure. If you wanted to pay yourself a $1 salary, you could. Then, any money you take out of the company could be taxed as a dividend, you would have to assume 100% control of your retirement, probably wouldn't be eligible for Medicare after you retire, but, there isn't anything illegal there.

I upvoted you; you clearly know more about taxes than me. However, let me chime in again here and say that the feast-or-famine thing seems overblown. The IRS isn't dinging you for miscategorizing income; it's dinging you for underpaying taxes. You can make your income as irregular as you'd like, as long as you end up paying what you owe.

If your income fluctuates based on profit and the IRS deems that a dividend, then, you are charged at the dividend rate rather than the personal tax rate. That dividend tax rate is higher than your income rate until you hit $373k annual salary in 2011/2012, and yes, you would get hit for underpaying taxes.

http://www.irs.gov/businesses/small/article/0,,id=101038,00....

Publication 535, mentioned further down under reasonable compensation talks further about how income is qualified.

Basically, if you pay yourself $8k/month, and in July have a really great month and pay yourself $40k, the IRS could determine that the $32k you gave yourself is a distribution of profit, and therefore a dividend. Even paying your taxes as if that was taken as a wage could end up being scrutinized by the IRS. If the IRS determines that your wage fluctuates as much as your profit does, and you're audited, you could have an issue.

Lets say you run a consulting company, pay yourself $5k/month, write an IPhone app, sell $200k, hand yourself $200k right there, it is possible that the IRS could take that view. The difference in taxes on $200k of income versus a dividend is 2% or $4000. If that is greater than 10% of the amount you owe at the end of the year, you could be subject to underpayment penalties of another few hundred. In the fictional $32k, the underpayment of tax would be $3200.

I'm not an accountant, but, if you run into any of these situations, you need to know when to talk with an accountant. Even thinking that you paid the proper tax is something best left to someone that does that for a living. And if you're going to find an accountant, do it in October.. give them your numbers for the current year and what you're projecting for the rest of the year and give them time. You still have room to maneuver a bit more than talking to him on March 14th when the forms are due March 15th. Tax planning is almost as important as tax filing.

Note: yes, I was audited due to the above situation - prior to having an accountant. Ironically, it was a contract with the Navy that did it - I thought, finally, I made this money, I am going to pay myself for all of the hard work I put into this and reward myself for the last two years of subsistance living. After all was said and done, the penalties and accountant fees were grossly disproportionate to the $2100 in underpaid taxes.

> That dividend tax rate is higher than your income rate until you hit $373k annual salary in 2011/2012

It was my understanding, confirmed by your link, that dividends are either taxed as ordinary income or at a maximum of 15% in case of qualified dividends.

You seem like you know what you're talking about so am I missing something?

If I recall, a qualified dividend is taxed as a capital gain - 15% for long term (> 12 months), 35% for short term based on the length of time you held the security/shares in startup/corp/whatever. A non-qualified dividend is taxed at your base tax rate. Bear in mind that a dividend can alter your base tax rate, which affects contributions you may have made throughout the year. So, if you were in the 15% bracket and because of this payment get pushed into the 33% bracket, not only do you need to compensate for the cash received, but, the potential tax liability from your new annual base.

If you are given shares in a company after the initial date, I don't know if that resets the calendar, prorates it, etc.

In my case, as the sole shareholder of a closely held Maryland S-Corp, the IRS deemed the cash payment to be a qualified dividend from a company that was 7 months old, therefore, 35%. Overall, it took roughly 2.5 years and about $7k in accountant fees to reconstruct my bad bookkeeping and deal with the IRS, $1.5k in interest and penalties for an unpaid $2100 tax liability.

Again, if your income ever goes crazy for whatever reason, talk with an accountant.

You really can't "cheat" with a C-corp. Your company's income is going to first be subject to corporate income taxes (30 to 35%). Then if you pay dividends, that is also taxed.

In other words, trying to skirt payroll taxes with a C-corp is going to end up with you paying more taxes than doing no hack. Hence, why the IRS rule only applies to S-corps which pass on their income and are not subject to corporate taxes.

Steve jobs effectively pays a 45% federal tax rate on income (35% corp on apple's income and then 15% long term cap gains on any shares he sells) -- so the IRS really doesn't care.

Well, apple ends up paying about 24% in corporate taxes, even though the corp tax rate is 35.

That's probably effective after all deductions, etc. 35% should be their marginal rate. So if the last $500k of income was converted into Steve's Salary their taxes should be dropping by 0.35*500k

A S-corp owner must take what the IRS deems to be a "reasonable salary" based on the overall profit of the company, and must pay self employment taxes (FICA, Medicare, etc.) on that amount.

The IRS does not give out much guidance on the definition of "reasonable salary" but has provided guidance on what is /not/ reasonable.

In this case the IRS evaluated the company's return and decided that his salary was less that reasonable and as such they went after him and got him to pay more tax.

This rule does not apply to C Corporations.

To be clear: the rule doesn't apply to C Corporations because they are taxed differently; it's not an oversight. It's the pass-through taxation structure of S Corporations that make this an issue.

If you are a C corporation, you get no pass-through. My consulting business is set up as a C corp, and my accountant makes sure that it earns no profit each year. This is mostly done by paying any excess as salary bonus. Corporate tax rate is too high to leave money there.

The C corp cost me a little more in terms of the deductions, but was a big win because when I set it up many years ago I put in the bylaws a medical provision such that any full-time employee would have health coverage (up to a limit) including health insurance premiums. This, due to the very high cost of health insurance, was a big win, as these are a business expense.

Were I to do it again, I would probably do LLC with the new way that health care is taken care of.

Thus, there is no issue like there is with the S-corp, because any money taken out of the corporation is done through payroll.

Social Security/Medicare/Workers comp get no money on passthrough from a c-corp either - c-corps pay taxes on profit, whereas s-corps pass any profit through to be taxed on individual returns of shareholders.

What would bother the IRS is that capital gains distributions are taxed at a different, lower rate than standard income, so taking distributions instead of income could reduce the total amount owed to the IRS.

(I'm not an accountant - if someone could verify or refute this, that would be nice)

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