When to Cut Yourself a Check

You work, you get paid. That's an easy concept to master when it involves employees, but things are more complicated for sole proprietors

By Karen E. Klein

Q: What are the requirements for paying myself a salary? I am the sole owner of an S-corporation. If it's not making any profit, or very little, is a salary mandatory? How do I handle this if not enough money is coming in to cover a salary? Also, how do I determine if my services are liable for sales tax? -- J.A., New York City


As the owner of an S-corp, there's no requirement that you take a salary. However, generally speaking, the IRS expects you to pay yourself what another employer might reasonably pay you for your services in similar business conditions. Tax authorities are watchful of S-corp owners who underpay themselves, experts say, because they often forego a salary in order to pay little or no personal income tax.

If your company has no profits, you should ask your accountant about the situation, suggests Mae Lon Ding, a compensation consultant with Personnel Systems Associates. "You may want to consider discussing with your legal and tax advisers whether you should officially note in the board minutes that you did not receive any salary, or an inappropriately low salary, due to financial inability of the company to pay you -- and the amount of underpayment," she says, adding: "This may be helpful if you think you might switch to a C-corporation in the future and want to pay yourself back in a very profitable future year."


  If you have even a small profit, your CPA may suggest that you pay yourself something. If you do take a salary, you would be subject to the normal withholding tax schedule -- and if your company records a loss, your salary would increase that loss, says Barry Garfield, an audit partner at Holtz Rubenstein, in Melville, N.Y.

"If you draw a salary and the S-corp has a loss, that loss won't be deductible on your personal tax return unless you have 'basis,'" says Garfield. "Basis" is the financial interest that the IRS determines that you have in the company, and it is calculated through past profits, capital contributions, shareholder loans, or previously taxed earnings. "If you don't have basis and your company records a loss, it wouldn't make any sense for you to draw a salary," adds Garfield. "If you do, you'll have to pay taxes on the salary, but you won't be able to claim the loss on your tax return."

Regarding your question about sales tax, there is no one-size-fits-all answer: Each state has its own rules laying out about which businesses must collect sales tax. In most cases, services like accounting and legal help are not subject to sales tax, but services like fixing the plumbing are. Again, your CPA will be able to advise you on whether you should be collecting sales taxes. You can also go to the Web site of the New York State Department of Taxation & Finance and read the section on sales tax, or contact the state's business-tax information center at: 800 972-1233.

Have a question about your business? Ask our small-business experts. Send us an e-mail at smartanswers@businessweek.com, or write to Smart Answers, BW Online, 45th Floor, 1221 Avenue of the Americas, New York, NY 10020. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.

Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues

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