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S-Corp Reasonable Compensation

November 15, 2019

Is This Your Situation: Confused About Salary Rules in an S-Corp
You're in business to make money to feed your family, send the kids to college or drive the sports car of your dreams. But when you're a shareholder in an S corporation, how and how much you get paid can be controversial and a red flag for the IRS.

What is an S corporation?

Businesses are organized in many ways. In an S corporation, business income and losses pass through the business and become part of each shareholder's personal tax return.

Why is that a good thing?

S-corp shareholders, who work as owners and employees, can save money on Social Security and Medicare taxes. The money they retain can be considered a distribution of earnings, which is exempt from payroll taxes.

Even better, S-corp officers and board members decide how much (or little) actual salary shareholders receive. If you own the S corporation where you work, you make that salary decision.

Who and how do S-corps pay?

The IRS is hip to the S-corp salary dance and dodge. In 2000, the IRS inspector general found that 440,000 single-shareholder S-corps paid no salary to the owner, robbing the government of billions of dollars.

The IRS has stepped up auditing S-corps and enforcing salary rules. And this is where compensation can get confusing, because the "rules" are not entirely clear.

The only real IRS guidance is that S-corp shareholders "who provide more than minor services to their corporation … must receive compensation subject to federal employment taxes."

This is where the trouble — and the lawyer bills — may begin. How should S-corps determine, exactly, what is reasonable compensation for services rendered? The IRS suggests looking at the following factors to determine what a reasonable salary would be:

Duties and responsibilities
Time devoted to the business
Training
Dividend history
Payments to employees who are not shareholders

Another way to determine reasonable compensation is to consider what other people doing the same work in similar-size companies earn. Check employment sites such as Salary.com to determine and substantiate for the IRS reasonable compensation for comparable positions. But it may be more complicated then just looking at Salary.com.

What do you need to do?

S-corp compensation issues can cause huge tax headaches, audits and penalties. That's why we're here. We have tools, available for you, that meet the above requirements and mitigate the risks associated with an IRS Reasonable Compensation challenge. Please contact Brent Ross in our office if you would like to discuss this issue further and/or to have Ross Hughes & Associates, CPAs complete a Reasonable Compensation Analysis with your input. A Reasonable Compensation Analysis is an independent, unbiased report that establishes your reasonable compensation, using criteria outlined by the IRS and Courts, and provides a defensible position to an IRS challenge. 



 

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