Question

Given a choice, would an S-Corp owner/employee rather take money out of his/her S-Corp as salary or as distributions? Be specific in your answer and provide an explanation.

What is the tax accountant's role in preventing the kind of abuse the article discusses?

Do other entity forms (C-Corps, Partnerships, and sole proprietorships) suffer from the same incentive related to salary? Why or why not?

Answer 1

The S-Corporation is liable to pay tax on income from business.  An S-Corporation can make distributions to the owner that will not be taxed in the owner's tax return provided the distributions are within the owner's basis. If the distributions are more than the owner's basis, the difference is treated as long term capital gain.

An S-Corporation owner / employee can also take salary as salary is deducted as an expense in the S-Corporation's AGI computation and taxed as income of the employee. The tax accountant may actually check whether services are rendered by the employee to S-Corporation otherwise may disallow the deduction of salary in S-Corporation and may treat the same as dividends that is subject to double tax (one tax on income of S-Corporation and another tax on dividends to owners).  

When a regular C-Corporation distributes its earnings out of its retained earnings, the distribution is called dividend that is also subject to tax at the owner's hand. However C-Corporation can pay a salary to its owner provided the owner has rendered services to C-Corporation. Otherwise, the distribution will be treated as dividend.