When computing compensation for employees and shareholders, S corporations may run into a variety of issues. The information below may help to clarify some of these concerns.
Reasonable Compensation
S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before any non-wage distributions may be made to the shareholder-employee.
Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for the service rendered to the corporation.
Several court cases support the authority of the IRS to reclassify other forms of payments to a shareholder-employee as wages subject to employment taxes (and possible penalties).
The following are several factors to help determine reasonable compensation:
- 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