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Reasonable Compensation of an S-Corporation

The IRS has recently announced that S-Corporations will be getting audited more due to the lack of shareholder compensation.

What is reasonable compensation?

Reasonable compensation is when an S-Corporation is paying an employee a reasonable amount of money for the service they did. When it comes to reasonable compensation it is important to make sure all the regulations are being followed because some things can be seen like a red flag in the eyes of the IRS. For example, the lack of the shareholder compensation in an S Corp can be seen as a red flag. We will be going over some of the ways to avoid getting audited by the IRS.

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Now, how do you know if what you are paying yourself is reasonable? Make sure that what you are receiving in that position within the S Corp is what a person would be getting paid for when doing the same job in a different company. Additionally, make sure the salary given to you is not below minimum wage, but also is not excessive from the appropriate wage.

When the court is trying to determine if you were giving reasonable compensation, they take some factors into consideration. The factors 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 businesses pay for similar services, compensations agreements, and the use of a formula to determine compensation. Reasonable compensation has a lot of factors that need to be taken into consideration when trying to qualify the employee for the right amount of payment. When evaluating the employees here are some of the factors needed to consider.

  • The qualifications and experience
  • The knowledge they have of the business
  • The time they must spend doing their work for the business
  • The economic conditions
  • The size of the business and the difficult situations they may face
  • The amount paid for the same position by competitors in the same area.

There are some resources available that allows you to see how much shareholder-officers paid themselves. Also, a good website to use if wanting to compare competitors pay is www.salary.com. In salary.com you would be able to see the amount competitors pay based on position of the employee and location. If you are an S-corporation and you need help to understand what you need to do to not get audited by the IRS contact us. We can help you.

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