I'm a partner in a S corp. We have recently started withdrawals for shareholders. Though we receive salaries, we are concerned about balance. Is it okay that a shareholders yearly withdrawal be larger than the yearly salary? Does this raise red flags with the IRS?

That depends on a variety of factors, such as how large are your salaries, how do the salaries match up with the duties performed, etc.

For example, let's assume that a law firm is organized as a S-corporation and has three lawyers (each owning 25% of the shares), with a para-legal who owns 10% of the stock, and three administrative staff who each own 5% of the stock. The firm in the past tax year distributed $800,000 in dividends to the owners based on the percentage of stock owned.

A lawyer could not expect a $20,000 annual salary (while drawing a dividend of $200,000) to go unchallenged by the IRS, because a $20K salary is NOT representative of what a lawyer would make ANYWHERE in the United States.

However, a member of the administrative staff in the same firm who is also owns 5% of the stock COULD draw a $20,000 salary and get a dividend of $40,000 without any scrutiny from the IRS, because a $20K salary for a staff worker COULD be representative of what such staffers would normally earn in that area of the United States.

If you are just a Shareholder and have a passive investment, you do not have to withdraw a salary. If the Shareholder is also an officer, the Corporation should pay a reasonable salary. What is reasonable? - is based on what the person could get paid as salary in if employed and paid by another company.

If the shareholders are the only employees, this becomes even more important.

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