REASONABLE COMPENSATION FOR SHAREHOLDER-EMPLOYEES OF S CORPS
S Corporations have been under additional scrutiny lately by the IRS as many small businesses have not been in compliance when it comes to reasonable compensation for reporting wages on a Form W-2.
1) Reasonable compensation is the value that would ordinarily be paid for like services by like enterprises under like circumstances.
2) Distributions 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.
3) Determining an employee’s reasonable compensation is dependent upon a number of factors and is not an exact science.
4) The key to establishing reasonable compensation is determining the services of non-shareholder employees, the capital and equipment used in performing services, and the actual services of the shareholder-owner.
5) Factors considered by the courts in determining reasonable compensation are: training and experience, duties and responsibilities, time and effort devoted to the business, dividend history, payments to non-shareholder employees, timing and manner of paying bonuses to key people, what comparable business pay for similar services, compensation agreements and the use of a formula to determine compensation.
All of the above points play a role of determining how much a shareholder-owner of an S corporation should get paid. We all understand that the goal is to save payroll taxes, but at what at price? Also, a very key point is the less wages reported, the less you can fund your retirement plans!
