What is Reasonable Compensation and Why Should I Care?

If you own all or part of a S-Corporation you are required to receive reasonable compensation as wages — subject to payroll taxes as an employee of that S-Corporation. Positions like President, Treasurer or Manager along with any other positions that requires you to provide services for the business should be included when calculating reasonable compensation. While calculating what is what is not reasonable can be complex, what is simple to understand is; 1) IRS has been talking about the problem of S-Corporate working shareholders failing to properly take reasonable compensation and the deficit this creates in Social Security and Medicare taxes, for a long time. 2) At least part of the 87,000 new employees the IRS is adding will be assigned to audit reasonable compensation.

A reasonable compensation audit could result in owner distribution or even loan payment being reclassified by the IRS to compensation. The result of this reclassification would be the assessment of additional Social Security and Medicare taxes, not to mention interest and penalties.

Now is the time to review exactly what services you provide for your S-Corporation. How much time do you spend and what is the value of those services and the time spent is? While you are at it it’s also important to document how you determined what the number for your reasonable compensation is. Before you get started you may want to learn just what kind of documentation and calculations the IRS looks for in reasonable compensation cases.

Need help evaluating your compensation and the documents required to support your position? Give us a call.