"S Corp Pay: Mastering Reasonable Compensation"

The article outlines the importance of reasonable compensation for S Corporation shareholder-employees, highlighting IRS guidelines, factors in determining pay, compliance consequences, and best practices to avoid common mistakes and ensure proper payroll tax adherence.


Understanding Reasonable Compensation for S Corporation Shareholders

Reasonable compensation for S Corporation shareholders is a critical area of compliance to ensure adherence to IRS guidelines. Below is an overview of the IRS guidelines and best practices.

Aspect Description
What is Reasonable Compensation? Reasonable compensation refers to wages or salaries paid to shareholder-employees of an S Corporation that are consistent with the value of the services they provide to the company.
IRS Guidelines The IRS requires S Corporations to pay shareholder-employees reasonable compensation before distributing non-wage income. This ensures proper payroll tax compliance.
Factors in Determining Compensation
  • The shareholder's role in the business (e.g., responsibilities and duties).
  • Industry standards and job-specific salaries.
  • Experience, education, and qualifications of the shareholder.
  • Time devoted to the business.
  • Company size and revenue.
  • General economic conditions.
Consequences of Non-Compliance If compensation is deemed unreasonable, the IRS may reclassify distributions as wages, subjecting them to payroll taxes and penalties.
Best Practices
  • Conduct salary comparisons using industry surveys or databases such as the Bureau of Labor Statistics.
  • Document the criteria used to determine shareholder compensation.
  • Consult a tax professional to ensure compliance with IRS rules.
  • Review and adjust compensation periodically to reflect changes in the business or industry.
Common Mistakes to Avoid
  • Setting compensation too low to minimize payroll taxes.
  • Failing to document the rationale for compensation levels.
  • Ignoring industry standards.
  • Distributing all profits as non-wage income without considering reasonable compensation.


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