The IRS is increasing its review of Subchapter S owners who take too much compensation as a stock dividend instead of ordinary income. The dividend strategy means the Subchapter S owner pays less in income, Social Security, and Medicare taxes. Information from the IRS shows > 4 million tax returns were filed as Subchapter S; in 2010, the average pay (ordinary income) for a Subchapter S owner was $35,700.
It appears the IRS rarely challenges Subchapter S wages that are at least close to the Social Security wage cap. The IRS is very aggressive on the issue of dividends being disguised as wages. The potential IRS penalties are called “vicious.”