S Corporation Shareholder Salary

What Exactly Does “Reasonable” Mean?

A simple way to determine a reasonable salary is by asking yourself what someone else would make in your position, “What is the salary of other business individuals with similar job duties, requirements, skills, and education?” If you offer your job to someone else with the same pay and they request a higher salary, then you might be underpaying yourself, which could raise flags when the IRS reviews your tax return. It could also be the opposite, your salary is more than what it should be based on company characteristics. Basically, you cannot have a salary below minimum wage or one that is an exaggeration of reasonable.

The IRS has summed up some of the important factors to keep in mind when determining the salary of an S Corp owner, which are:

• the duties that were performed by the employee
• the overall volume of business handled
• the type of work and amount of responsibility
• the complexity of the business
• the amount of time and effort devoted to the business
• the timing and manner of paying bonuses to key people
• use of a formula to determine compensation
• the cost of living based on the district
• the ability and achievements of the employee
• the pay compared with the gross and net income of the business, as well as with distributions to shareholders
• the company’s policy regarding pay for all employees
• the payment history for each employee

Remember, Your Salary Is Not Based on the Company’s Earnings and Losses

Your salary may even add to the losses of the company bringing the losses significantly lower than anticipated. For instance, the company’s overall earnings were $250,000 minus owner’s salary of $175,000, the earnings are really 75,000. Therefore, your salary is a reflection of your duties and participation, even if it negatively affects the earnings of the company.

How to Be in the Safe Zone? Document!

The best way to avoid audits from the IRS and to defend claimed compensation is to accurately document all research supporting the amount. Documentation should be detailed and clear with all the time, expenses, labor, and work that was done to receive the earnings. Then, with all the supporting documents it is in best interest to discuss it over with your CPA to agree upon a reasonable salary. The documentation should be ongoing and meetings with your CPA should be yearly.

*Disclaimer: this is not tax or legal advice – consult with a CPA to speak of your direct situation since every business is different.