Rules for an S-Corp and How to Manage Reasonable Compensation
An S-Corporation (S-Corp) is a popular business structure that offers the benefits of limited liability protection, like a corporation, while allowing profits and losses to pass through to shareholders’ personal tax returns. However, to maintain S-Corp status, there are certain rules and requirements that business owners must follow—especially when it comes to reasonable compensation.
Understanding Reasonable Compensation
One of the most critical rules for S-Corps is ensuring that shareholders who work for the business pay themselves "reasonable compensation." This means the salary must reflect what an employee with similar duties would earn in the open market. The IRS is strict about this rule and will scrutinize compensation to ensure it isn’t too low, which can lead to tax avoidance by taking more distributions instead of a salary.
How to Manage Reasonable Compensation
To manage reasonable compensation properly, consider the following steps:
Industry Benchmarks: Research what similar roles in your industry pay. You can use salary surveys or tools like the Bureau of Labor Statistics (BLS) to determine appropriate compensation for your role.
Avoid Underpayment: Don’t rely too heavily on distributions from the S-Corp to reduce your payroll taxes. Paying yourself an unreasonably low salary can trigger IRS audits and penalties.
Consider Your S-Corp Profits: Your salary should be in proportion to your company’s profits. A small business with limited income may pay less than a larger, more profitable one.
Consult a Tax Professional: An accountant or tax advisor can help you calculate a reasonable salary based on your role, the company’s financials, and industry standards.
Keep Accurate Records: Make sure to document how you arrived at your salary decision. Having clear documentation helps if the IRS questions your compensation levels.
Final Thoughts
Managing reasonable compensation as an S-Corp owner is crucial for maintaining compliance and avoiding penalties. By following industry standards and consulting professionals, you can ensure your salary is fair and aligned with IRS requirements.
Need Help with Your S-Corp Compensation?
If you're unsure how to determine reasonable compensation or need assistance managing your S-Corp taxes, contact us today. Our team can help you navigate the complexities of S-Corp taxation and ensure you're in compliance with IRS rules.
