An officer at a S corporation would curtail her tax bill by lowering her salary or lower distribution and why How would you record the journal entries?

Answer 1

For tax puposes, the entire net profit or loss of an S corporation passes through to the owners' personal tax returns. Let's assume one owner and the company had Net Income of $10,000 and no salary has been paid to the owner. The $10,000 becomes normal income on the ownwer's tax return. Let's assume she's in a 20% tax bracket, she pays $2,000 in income tax. If she takes a $5,000 salary, she has $5,000 of Gross pay and the company has a $5,000 deduction for salary expense. However, this money is subject to FICA taxes for both the employee (7.65%) and the company (7.65). So the company's Net Income is $4,617.50 (10,000 - 5,000 salary - 382.50 FICA tax expense). This passes thru to the owner who now has total income of $9,617.50 (5,000 salary + 4,617.50 Sub-S) and would pay 20% income tax of $1,923.50. So her income tax is lower, however, a total of $2,688.50 has been paid out in taxes (1,923.50 income tax + 382.50 employee FICA +382.50 employer FICA). So an owner keeps more of the company's profits, and pays less to the government, by taking a lower salary. It should be noted that there is a maximum salary subject the Social Security portion of the FICA taxes. The max for 2007 is $97,500 (it goes up every year). After that amount is paid in salary, both the employee and the employer are only subject to the Medicare portion of FICA which is 1.45% employee + 1.45% employer. So the impact of lowering the salary is much less if the owner has a salary above 97,500...but there would still be a savings by lowering the salary. All of the net earnings are taxable to the individual whether they are paid out or not. When the Sub-S company actually makes a non-salary cash distribution to an owner, you would normally debit a contra-account in the Retained Earnings section called Shareholder Distributions and Credit Cash.