Legal Question in Business Law in California

The first is a very complex question. Among other things, it depends heavily on how well the company is doing. Many relatively new small businesses do not have significant earnings or even positive cash flow, and therefore the owners don't take out any money at all, either as wages, salaries or distributions.

If and when the company has sufficient cash flow before payments to owners, the owners should review the books and their personal situations and decide whether cash shouyld be returned based on payment for services or distributions of net profits. The company's accountant should be consulted as well as its attorney.

Some key considerations include the fact that if money is taken out as wages or salaries, it will be subject to payroll taxes, and the employee/owners will come under the worker's comp laws, although they may be, or become, exempt from coverage and payment. An advantage of payment of wages or salaries is that the compensation will induce the owners to work for the company and reward those who do, whereas dividends and distributions should be equal on a per share basis.

Many larger and successful S corporations pay officer-shareholders up to the social security maximum deduction amount, then take the excess as dividends, in order to maximize their contribution and the tax deduction. Ask your accountant for a full explanation.

The IRS has been known to expect corporations to pay their officer/shareholders reasonable salaries, neither excessively high or low. The state expects corporations not to pay dividends or make distributions in excess or profits or retained earnings.

The only way to make someone an owner of a corporation is to make him/her a stockholder. A person can be made a stockholder either by (a) the corporation issuing new stock to him/her, or (b) an existing stockholder selling him/her some already-issued shares. If the corporation issues the stock, it should receive fair compensation of some kind; it cannot make a gift unless all the stockholders consent or there is some other justification (such as incentive to a key employee). Also, do not issue shares in excess of the corporation's maximum authorized amount, and make sure to comply with Corporation Code 25102(f).

Finally, note that a California corporation with three or more shareholders must have at least three directors.

Mr. Whipple's answers are usually outstanding, but I'm afraid he threw an airball on this one. The entire reason for electing subchapter S treatment for your corporation is to conduct its financial affairs as a partnership and be taxed accordingly. Therefore your compensation is treated the same as a partnership draw and it is reported on Schedule K's issued to each of you. Talk to a good accountant for more details.