Q: Was I required to treat myself as an employee anyway and put myself on a payroll with all applicable taxes, even though my "salary" was not coming from the business earnings?
A: Where was your salary coming from? What is the structure of the business? Sole proprietorship, LLC, S-Corp or other? As a sole proprietor or a single member LLC, no, you are not required to pay yourself a salary. However, as an S-corp, you are required to have paid yourself a reasonable salary. See the following regarding S Corp salary requirements.
Who’s an employee of the corporation?
Generally, an officer of a corporation is an employee of the corporation. The fact that an officer is also a shareholder does not change the requirement that payments to the corporate officer be treated as wages. Courts have consistently held that S corporation officer/shareholders who provide more than minor services to their corporation and receive or are entitled to receive payment are employees whose compensation is subject to federal employment taxes.
The Treasury Regulations provide an exception for an officer of a corporation who does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration. Such an officer would not be considered an employee.
What's a Reasonable Salary?
The instructions to the Form 1120S, U.S. Income Tax Return for an S Corporation, state "Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation."
The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly. However, if cash or property or the right to receive cash and property did go the shareholder, a salary amount must be determined and the level of salary must be reasonable and appropriate.
There are no specific guidelines for reasonable compensation in the Code or the Regulations. The various courts that have ruled on this issue have based their determinations on the facts and circumstances of each case.
Let me know if you require further assistance with this matter.