S Corporations and Reasonable Compensation

I want to remind S Corporation shareholders of their responsibility to accurately determine and document Reasonable Compensation for services provided to your business.  Reasonable Compensation is the salary or wages that you, a shareholder-employee of an S Corp, pay yourself for the work you perform for your company.

The IRS requires that all shareholders of S Corps who perform services for their company pay themselves Reasonable Compensation, and it should be paid prior to taking any distributions.  You should be aware that under Rev. Rul. 74-44, the IRS will re-characterize distributions paid to shareholders as salary when such distributions are paid in lieu of reasonable compensation. 

There are two ways to think about Reasonable Compensation:

1.      Replacement Cost:  What would it cost your company to pay someone else to provide all the services you currently provide?

2.      Fair Market Value:  What would other businesses in your community pay you for the services you currently provide to your company?

The key to establishing reasonable compensation is determining what you do for your S Corporation.  In addition to direct generation of revenue, you should also compensate yourself for administrative work.  It is important that you research and document how you reach your Reasonable Compensation figure.

We are here to assist you with this issue and have tools available that can help you accurately determine your Reasonable Compensation figure.  Please contact us if you would like to discuss this issue further or to have me prepare a Reasonable Compensation Report for you.

A Reasonable Compensation Report is a detailed report that establishes your Reasonable Compensation using criteria outlined by the IRS.  To generate a Reasonable Compensation report we would complete a short interview (15-20 minutes).  When complete, we will go over the report and make any needed changes before locking in your Reasonable Compensation figure.

The best time to establish your Reasonable Compensation figure is now, before an IRS examination.  Reasonable Compensation has become an IRS hot button and we have been told to expect an increase in examinations of S Corps.  Completing a Reasonable Compensation Report is easy and provides a defensible position to an IRS challenge.

If you are currently taking a salary, it may be time to revisit it to determine that it is reasonable.  If you are not currently taking a salary from your S Corp. then it quite possibly may be time to start. 

If you are interested, please contact us so that we can discuss this issue further.