Tax Court Rules S Corp Payouts Are Wages

In a new case, Ward, TC  2021-32, 3/15/21, the Tax Court determined that payments from a law firm to its sole shareholder were, in fact, wages for tax purposes. 

Background: With an S corporation, items of the income is passed through to shareholders, who pay tax on their proportionate share of the income on their personal returns. Unlike C corporation owners, there is no “double taxation” on both the corporate and personal levels.

Notably, S corporations may pay their employee-shareholders little or nothing in the way of wages. If distributions are paid to these taxpayers instead of wages, they do not have to pay any federal payroll taxes on the amounts received. Thus, the IRS may challenge the characterization of payments from an S corporation to its employee-shareholders.

The taxpayer in the new case, an attorney in Minneapolis operated her law firm as an S corporation where she was the sole shareholder. For 2011 through 2013, the firm employed one other attorney, who was paid an annual salary. But the taxpayer herself didn’t report any wage payments for the tax years in question.

The problem: The payments reported the taxpayer personally during this time simply didn’t match up with the reporting by the S corporation and were suspect. For instance, the corporation correctly reported the wages paid to the other attorney, but did not treat the $62,000 amount paid to the taxpayer in 2011 as wages subject to payroll taxes. The taxpayer didn’t even report any of this amount as income.