Reference no: EM132699983

Silvia is President of the corporation and manages the law practice for the firm. Jose is secretary of the corporation but is not involved in the practice or operations of the firm. He serves as a capital investor as needed. For the past five years, Alvarez, PC has been organized as an S corporation, which they would like to continue. Prior to being an S corporation, it was organized as a sole proprietorship under Silvia Alvarez. Jose, who previously worked as an attorney at an oil and gas company, joined Silvia as a 50% shareholder when the PC was created.

For the current year the PC plans to pay Silvia a salary of $30,000 but no salary to Jose since he is not involved in the operations of the firm. The PC expects business net ordinary income for the current year to be $250,000 (before any salary payments to the owners). The owners will each take cash distributions of $100,000. Because the business is structured as an S corporation, the owners assume that they will not be subject to any payroll taxes on their share of the profits or their distributions, but only on Silvia's $30,000 salary.

Problem 1: What is wrong with the company tax issue? What is the reasonable compensation to shareholder-employees of S corporations.