Determining Reasonable Compensation for S-Corp Officers

What is Reasonable Compensation? Reasonable Compensation is defined by Treas. Reg. § 1.162-7(b)(3) as the amount that would ordinarily be paid for like services by like organizations in like circumstances, and this standard is adopted in Treas. Reg. § 53.4958-4(b)(1)(ii)(A).

How do you know if you're paying yourself a "reasonable compensation" as an S-corp officer? Determining reasonable compensation has many facets. We highly suggested you seek the guidance of a tax professional versed in determining compensation, but in a nutshell it starts with evaluating what the shareholder-employee did for the S corporation and those activities impacts on the organization's gross receipts. The more directly gross receipts were generated by the shareholder-employee's services often equate to a greater proportion of payments to shareholders should be treated as W2 wages instead of non-wage distributions. Conversely, the higher proportion of gross receipts generated by services of non-shareholder employees and capital and equipment often are used to support justifications that a higher proportion of payments to the shareholder could be justifiably treated as non-wage distributions that are not subject to employment taxes. Beyond evaluating gross receipts, the shareholder-employee should also evaluate the "replacement value" for hiring someone to perform the shareholders duties as an employee. Some suggest detailing the time & impact of administrative work performed by the shareholder vs. managerial or higher level expertise work which comes at a higher cost if one were to try and replace the shareholder-employee.  For example, bill payment, clerical work being performed by a shareholder might be tracked at a lower replacement value rate than advising a shareholder-employee may be providing to other employees in the organization.

Further Guidance Resources: In Oct 2014, the IRS published this 28 page job aide cover reasonable compensation issues for IRS valuation professionals, revenue agents and IRS field personnel. We also have found resources & tools compelling to those looking to bulk up their compliance stance in this matter.

More from the IRS: Other factors in determining reasonable compensation according to the IRS,

  • 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
  • The use of a formula to determine compensation

Disclaimer: This information is provided as a self-help tool and does not constitute legal or financial advice. Laws, regulations and lending products are changing daily and decisions as to whether or how to use this information and/or what actions to take are solely those of the employer. The providers of this information disclaim any and all responsibility and liability for its accuracy, completeness or fitness for your particular business purposes.