Earlier quoted context omitted.
Out of curiosity, are there tax options (specifically, retroactive ones) for this situation? As near as I know: (1) they formed a company at some point in the past (S-corp?), (2) they did constant work per year, (3) they had some donations per year, (4) they suddenly had a large amount of revenue in 2022 I'm guessing they didn't fully account for their time/expenses in prior years. If they didn't, are there options t…
IANAA, but I pay one every year. S-Corp is not an efficient entity type for a windfall like this. It is a pass through entity, and cannot retain earnings year over year, for that you need a C-Corp. That said, had they already had a C-Corp set up, then this income would be taxed at 21%, so after Steam fees and taxes, they would be sitting on around $3.3M (not counting publisher fees and any expenses that might arise).…
What you suggest is not a hack of the tax code. Close corporations are generally required to pay reasonable salaries to their owners (and more importantly, payroll taxes on those salaries) if the corporation's revenue is derived from the labor of its owners. Not doing this is the #1 reason that close corporations, and their owners get penalized by the IRS. From personal experience being brought in to put out these fires, the IRS might be willing to negotiate the size of the penalty, but penalties will be owed, as will back taxes on the tax deemed due, as well as interest on those back taxes. Generally, these close corporation owners will spend more on penalties and interest for a single tax year than they would save in 5 years from this scheme, and that doesn't include legal fees they paid for the audit.
There is no bright-line rule for what a "reasonable" salary is. For low six-figure amounts, the SS contribution threshold is usually considered a safe amount with the rest paid as a dividend, but for seven-figure amounts, different considerations apply. Indeed, at larger amounts, the IRS is actually opposed to close corporations using inflated salaries to reduce corporate income taxes (because salaries are deductible to the corporation but dividends are not).
So: owners would have paid their progressive rate on the XXXk of income received as salary (which is deductible to the corporation), at a likely 22-37% marginal rate, plus up to 12% state income tax rate, for a total of up to 49% including state taxes. The remaining income received as a dividend would be subject to a corporate tax rate of 21%, plus a personal tax rate of 20% (15% on the portion of the dividend income, if any, below the QD 20% rate threshold, which depends on how much of their income they chose to allocate as salary), plus 3.8% NIIT, or a 44.8% rate of federal tax before state taxes on the corporation and the owner are taken into account. Or in other words, usually worse than just taking all of the profits as a salary.