It's taxed as regular income, but the premise under which it's exempt from the payroll taxes every other worker has to pay is that it's not normal income, but rather the return from an investment in the company.
For people in our industry, it's hard to see a definition of "reasonable" that would be financially beneficial. You start a tech company. You pull $100k out every year, putting you right smack in the middle of the income distribution for experienced tech people. But because of a loophole, you get to reclassify $50k of that $100k as a distribution, and not pay FICA on it. To support that (sorry) scam, you claim $50k is your "reasonable" salary --- putting you way on the low side of the industry. How convenient.
People obviously do it and get away with it. I'm glad it's an audit flag.
Sure, but you just mentioned an unreasonable salary. If the median is $100k, then that's reasonable, and the person only gets to avoid SS and medicare on any additional profit.
I operate as an s-corp and pay myself a reasonable salary, matching that of the salary I could get in the current job market in the area I live in. Anything I clear above this is only taxed with my regular taxes.
If I was running a C-Corp instead of an S-Corp, I'd get my $100k salary, and any extra would have been taxed at the 30% corporate rate when it was taken in, then the 20% capital gains when it's distributed to me as profit.
Is your "dream job" one where you are paid a pittance while the company owner makes a tidy profit from your endeavours?
Many people will take a pay cut for their dream job, but very few are willing to be exploited in the process.
If a company owner is taking a very low salary in order to maximise company profit (and minimise tax) then they (as an employer) are exploiting themselves (as an employee) to do so.
I might take a $50,000 salary to fly gliders all day. But no matter how nice of a job it is, I'm not going to take a $50,000 salary to program computers all day, because I can get a job in that field that's only marginally less nice and pays way more.
For people in our industry, it's hard to see a definition of "reasonable" that would be financially beneficial. You start a tech company. You pull $100k out every year, putting you right smack in the middle of the income distribution for experienced tech people. But because of a loophole, you get to reclassify $50k of that $100k as a distribution, and not pay FICA on it. To support that (sorry) scam, you claim $50k is your "reasonable" salary --- putting you way on the low side of the industry. How convenient.
People obviously do it and get away with it. I'm glad it's an audit flag.