Discover how Reasonable Compensation for S Corporations works
Reasonable compensation involves determining the salary or wages that shareholder-employees of an S Corporation should receive for their services.
This determination is crucial for tax purposes as it affects the distribution of earnings and the taxes levied on both the corporation and the shareholder. It must reflect the value of the services provided, considering factors like industry standards, employee roles, and company financials.
Required documents
To establish and justify reasonable compensation, you will need:
- Documentation of salaries paid for comparable positions in similar companies.
- Records of the time and duties performed by the shareholder-employee.
- Financial statements of the company to correlate compensation with business size and capacity.
Benefits of Reasonable Compensation for S Corporations
- Tax Compliance: Properly determined compensation helps avoid IRS scrutiny and potential penalties.
- Financial Clarity: Clarifies the distribution of company profits and taxes between salary and dividends.
- Equitable Treatment: Ensures shareholder-employees are compensated fairly relative to their contributions to the company
Factors Influencing Reasonable Compensation
- Role and Responsibilities: The scope of the shareholder’s duties and their involvement in business operations.
- Industry Standards: Typical compensation for similar roles in the industry.
- Company Profitability and Revenue: Compensation relative to the business’s financial performance.
- Professional Experience and Expertise: Qualifications and experience of the shareholder-employee.
Important considerations
Reasonable compensation is scrutinized by the IRS to prevent tax evasion through misclassification of corporate earnings. The compensation must be substantiated with clear, documented justifications.
Periodic reviews and adjustments may be necessary as the business evolves and the roles of shareholder-employees change.
For more detailed information, please refer to the IRS guidelines on S Corporation Compensation and Medical Insurance Issues.