Corporations and Compensation

Although management in an S-Corporation and a C-Corporation may be very similar, wages may differ due to tax treatment of the entities. In an S-Corporation, shareholders are inclined to pay themselves a lower salary and take a larger distribution - taxed at ordinary rates on the flow through to the individual 1040. However, in a C-Corporation, income is taxed first at the entity level, and then again as a dividend. But C-Corporations have one major advantage over an S-Corporation, and that is the deduction of fringe benefits. A C-Corporation can deduct health insurance, and other fringe benefits paid to shareholders directly from income. In an S-Corporation, health insurance is added to the W-2 and taxed at the individual level. So in an S-Corporation reasonable compensation is essential as a lower wage may result in dividends being reclassified as wages. In a C-Corporation, high wages may be considered to be too substantial and reclassified as dividends, if wage and bonuses are to high. Therefore, before deciding on salary levels, it is best to check what is an equitable wage according to the IRS, and pay the dividend tax in C-Corporations.