An S corporation is a pass-through entity that is treated very much like a partnership for federal income tax purposes. As a result, all income is passed through to the shareholders and taxed at their individual tax rates.
However, the nature of the shareholders’ income is subject to IRS scrutiny, especially if the shareholder provides more than minor services to the corporation. Shareholders who receive, or are entitled to receive, payment for services are considered employees whose compensation is subject to federal employment taxes.
This becomes problematic if shareholders have not received “reasonable compensation” for services rendered to the corporation, but have received significant corporate distributions of cash and property or corporate loans.
So, what is considered reasonable compensation?
There is no magic number - no one-size-fits-all answer - that one must meet in order to satisfy this requirement. There are many factors that are considered when determining reasonable compensation. These include the time and effort devoted to the business, duties and responsibilities, training and experience, payments to non-shareholder employees, and what comparable businesses pay for similar services.
Due to the high number of components that can affect this determination, it is recommended that anyone concerned about reasonable compensation speak with a tax professional about their specific situation before making a decision.
Do you need help?
The information on this page is to be used as general guidelines for S corporation reasonable compensation. It is always our goal to bring you as much information as possible in a digestible, easy-to-understand way. With that being said, there are many nuances to the Internal Revenue Code and for every rule, there is an exception.
If you feel you are not paying yourself a reasonable amount for the services you are performing or if you have any specific questions regarding S corporations, contact your favorite team member at DiMercurio Advisors or click the button below.