Compensating an S
Corporation Shareholder
What is Considered Reasonable?
If you are a corporate officer-shareholder of an S corporation performing services for
the corporation, you must pay yourself a "reasonable salary."
Corporate officers are considered employees of the corporation by law.
The IRS has not defined reasonable compensation in the code or
regulations. However various courts have ruled on this issue based on the
facts and circumstances of each case.
Some of the factors the courts look at to determine reasonable
compensation include training and experience, duties and responsibilities,
time and effort devoted to the business, dividend history, payments to
non-shareholder employees, timing and manner of paying bonuses to key
people, what comparable businesses pay for similar services, compensation
agreements, and the use of a formula to determine reasonable compensation.
S corporations should not attempt to avoid paying employment taxes by
having their officers treat their compensation as cash distributions,
payments of personal expenses, and/or loans rather than as wages. The IRS
could reclassify these amounts as compensation to the shareholder/employee
resulting in additional taxes and significant penalties for the S
corporation.
