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If you perform services for an S corporation in your capacity as an officer/shareholder, the IRS is concerned that adequate payroll tax might not be paid. If you render more than minor services and are not paid a salary (or are paid a nominal salary), the IRS may find the S corporation liable for employment taxes on amounts being paid out to you as distributions. In addition, the IRS could assess substantial penalties for noncompliance of wage withholding rules.
RECENT CASE * In Joseph M. Grey, P.C. v. Commissioner, 119 T.C. No. 5, the S corporation taxpayer was found subject to employment taxes for amounts paid to its president. The taxpayer argued that its sole shareholder/president was not an employee (and therefore was not paid a salary) since it didn't control his work and that the payments made to him were only distributions of pass-through income.
The Court's Decision
An officer is a statutory employee under Section 3121(d) unless he or she "does not perform any services or performs only minor services and ... neither receives nor is entitled to receive, directly or indirectly, any remuneration ..." Since the president's services were ongoing and substantial, the court found the S …