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Reasonable Compensation for S-Corporation Owners

As the owner of an S-Corporation, you’re probably aware there is a tax advantage to taking money out of your business as a distribution rather than as compensation (salary and bonus). The reason is simple, S-corporation earnings are currently not subject to FICA taxes.   However, there is a minimum expectation on what wages should be for the services performed by the Owner/Employee. As a practical matter, the IRS rarely raises the issue of unreasonable compensation when the amounts are higher than the FICA limits.

How much compensation is “reasonable”? There’s no simple formula. IRS tries to determine the amount that similar companies would pay for comparable services under like circumstances. Factors that are taken into account include:

  • the employee’s duties;
  • the amount of time required to perform those duties;
  • the employee’s ability and accomplishments;
  • the complexities of the business;
  • the gross and net income of the business;
  • the employee’s compensation history; and
  • the corporation’s salary policy for all its employees.

There are a number of steps you can take to make it more likely that the compensation you earn will be considered “reasonable”.  For example, you can:

  1. Make a complete list of all the services you provide to your S Corp
  2. Apportion your time among all the services listed
  3. Rate your level of expertise and experience for each service performed
  4. Gather wage data on all the services listed and at the appropriate level of expertise
  5. Assemble all your research and data and calculate your Reasonable Compensation figure

Keep in mind that determining a Reasonable Compensation figure is far from an exact science.  It is important that you research and document how you determined your Reasonable Compensation figure, and keep your explanation and all back-up documents and reference sources in a place where you can find them if the IRS comes calling.

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