S-Corporation “Reasonable Compensation”

November 06, 2020

What is the reasonable salary for an S-Corporation Officer? A frequently asked question from many including my clients!

The answer however is not simple. The taxpayer prefers “All Distribution” vs. “W2 wages”, so they can avoid paying FICA Tax which is 15.3% (Employee and Employer Portion).  The IRS requires “Reasonable Compensation” for S- Corporation Officers.

The term “Reasonable Compensation” is too vague and subjective. In addition, there are no specific guidelines for “reasonable compensation” in the Tax Code or Regulations.

Officer’s salary of $36,000 could be “Reasonable” for certain S-Corporation but not for others, so, the question is how to determine so called “reasonable compensation”? Is there a magic number?  The answer is NO.

The solution is that each and every situation could be different & the “reasonable compensation” has to be determined by analyzing several factors.   Below are some of the factors courts have considered while determining “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 personnel
  • What comparable businesses pay for similar services
  • Compensation agreements
  • The use of a formula to determine compensation

A simple and pragmatic approach to this issue is that S-Corporation Officers must have a W2, so the line 7 of the 1120S Form (Compensation of officers) does not have a “Zero” which sticks out like a sore thumb. In addition, the closer the W2 wages are to the FICA limit (for 2021 it is $141,900) the safer you are.

By Sal Ghulamali, CPA

He could be contacted at sg@taxcpa1.com

Visit our website: TAXCPA1.COM

This article is for the purpose of providing general information only. It does not provide tax/legal advice for any particular person, entity or situation. Each situation is different and you should consult a CPA/Attorney with complete and pertinent details.

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