Reasonable Compensation of an S-Corporation Officer

In many of the conversations that I have with new business owners, the sentiments of, "I don't want to pay more taxes than I have to," or "I'm okay taking positions in the 'grey' area," are expressed.  I understand those feelings and I don't want to pay more taxes than I have to either.  I feel it is my job to understand the tax code as best as I can and work with my clients to help them understand what is legal, what is illegal, what is aggressive, what is conservative and coach them to tools that are legitimate tax strategies that will help them save on their tax bill.

One of the areas that I feel is not clearly defined by the IRS is the reasonable compensation rules surrounding the pay of an owner of an entity that is taxed as an S-Corporation.  There are so many variables in what reasonable compensation means that the IRS can't clearly define what it means for every situation.  Variables such as profession, location, knowledge and expertise of the owners, and many other factors contribute to what a reasonable compensation is.  I feel it appropriate to think that reasonable compensation has a range that you could fall into and be safe.  Within that range there is a safer side and a more aggressive side in regards to being protected from IRS scrutiny.  I'm happy to have a conversation with my business owner clients to see where their personal stance falls and coach them to staying in the safe range.  It's okay to be on the conservative side and it's okay to be on the aggressive side.  Being reckless, though, can expose you to an IRS audit and penalties.

Below are some considerations and factors to consider when determining what reasonable compensation is:

1. Industry Norms: The nature of the business and industry practices set the foundation for reasonable compensation benchmarks. Comparing salaries within similar roles and industries can provide valuable insights.

2. Duties and Responsibilities: The level of involvement, skill set, and time devoted to the business impact reasonable compensation. Owners who actively manage the company, engage in strategic decision-making, and perform day-to-day operations are likely to warrant higher compensation.

3. Experience and Expertise: An owner's qualifications, experience, and specialized knowledge influence their value to the company. Higher levels of expertise may justify higher compensation.

4. Geographic Location: Compensation levels can vary significantly based on the cost of living in a particular region. Adjusting compensation to align with local market rates is crucial.

The end goal of determining a reasonable compensation is to pay the owners a fair wage in the eyes of the IRS.  Some business owners may want to be on the low-end of the pay scale to save on payroll taxes while other business owners may want to be on the higher-end to eliminate the risk of an IRS audit or to help them meet financing requirements.  There are also many other considerations to think about before determining what a reasonable compensation should be for your situation.  If you have questions or concerns about what reasonable compensation should be for you, please reach out to me and we can schedule a call or an appointment to go over your situation.

Disclaimer: This blog post was created with the assistance of AI tools.  Bruner CPA Services would love to have more hours in the day to fully understand the intricacies of SEO and how best to create meaningful content that helps their website remain relevant.  But alas, the robots can do it better.  As such, AI tools were used to help create this blog post with review, edits, and additions made by Bruner CPA Services.