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S Corporation Officers — Do You Pay Yourself a Reasonable Salary?


Are you an owner (part or full) of an S Corporation? Then you need to know about how to compensate yourself properly. For many small business owners, the amounts and types of compensation are often determined by whether or not the business is making a profit. But the IRS does actually provide rules about officer compensation, and when you follow these rules, you stay out of trouble. 

So, what should you know about compensation for your work? Here are a few answers.

Why Does the IRS Care? 

Why, you might ask, does the IRS care whether or not you take a salary or how you might compensate yourself for all the time and effort you put into your own business? The answer is largely because the issue skirts the payment of taxes. 

If a business owner compensates themselves by having the business pay monthly bills for their home, they don’t pay any taxes. They did not pay Medicare, Social Security, or income taxes on what they received. If that person were simply allowed to use the business to pay expenses and not declare the income for tax purposes, everyone would start doing so. After all, no one enjoys paying taxes!

You do get some benefit from the proper calculation of compensation as well. First, your books will be more correct because the business includes all expenses rather than leaving a big one out. And you may be able to reduce your tax burden by opting for a business structure that limits how much income is assigned to you for tax purposes. 

What Are the Guidelines?

So, if you must take a proper salary in order to stay on the IRS’s good side, what are the rules? The IRS is intentionally vague about this subject, which leaves room for each business to tailor compensation to their individual situation. Basically, the direction is that each shareholder-owner who performs services for the company (usually as an officer, such as a CEO) must be paid reasonable compensation. 

Reasonable compensation is not defined, but it is generally considered to be what a similar person who performs similar duties for a similar company might receive as a salary. 

How Can You Determine Your Salary?

So, how can you and your business determine what a reasonable salary is? This will take some figures and research. First, you’ll need to quantify a few factors. These include:

  • Hours and days worked.Obviously, if you work full-time as you oversee the business, your compensation would be significantly higher than that of a part-time worker. 
  • Training and skills.A construction company shareholder with an extensive construction background would earn more for jobs than a new person with no construction training.
  • Duties and responsibilities.A company CFO who makes the big financial decisions earns more than a data entry technician. If two shareholders do these jobs, one would have higher compensation. 
  • Other employees’ wages.If you have other workers, your compensation might be compared to theirs. A CEO who takes a lower wage than an intern may not be considered as receiving reasonable earnings. 
  • Other business income.Finally, the amount of your salary may be compared to what other money you get from the business. If you take $10,000 in dividends or nontaxable benefits each quarter but only $1,000 in salary, the ratio might be a red flag to the IRS. 

Once you have written down what you do for the business, how much you do it, and what your responsibilities are, compare these with job postings available online or through local salary comparison services. You should also speak with other similar businesses in your region or in comparable regions. And record your findings in case you need to prove this effort to the tax agency. 

Reasonable compensation is not defined, but it is generally considered to be what a similar person who performs similar duties for a similar company might receive as a salary. 

How Can You Determine Your Salary?

So, how can you and your business determine what a reasonable salary is? This will take some figures and research. First, you’ll need to quantify a few factors. These include:

  • Hours and days worked.Obviously, if you work full-time as you oversee the business, your compensation would be significantly higher than that of a part-time worker. 
  • Training and skills.A construction company shareholder with an extensive construction background would earn more for jobs than a new person with no construction training.
  • Duties and responsibilities.A company CFO who makes the big financial decisions earns more than a data entry technician. If two shareholders do these jobs, one would have higher compensation. 
  • Other employees’ wages.If you have other workers, your compensation might be compared to theirs. A CEO who takes a lower wage than an intern may not be considered as receiving reasonable earnings. 
  • Other business income.Finally, the amount of your salary may be compared to what other money you get from the business. If you take $10,000 in dividends or nontaxable benefits each quarter but only $1,000 in salary, the ratio might be a red flag to the IRS. 

Once you have written down what you do for the business, how much you do it, and what your responsibilities are, compare these with job postings available online or through local salary comparison services. You should also speak with other similar businesses in your region or in comparable regions. And record your findings in case you need to prove this effort to the tax agency. 

Where Should You Get Help?

Still need help complying with IRS rules about reasonable compensation? Consult with an experienced CPA in your area. Monheit Frisch Group PLC can help. Make an appointment today to learn more and see how following these important guidelines can help you and your business grow and thrive. 

 

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