S Corporations, Wages & Compensation to Officers - What is Reasonable Compensation?
With tax season finally upon us, it is time to revisit the wages and salaries of all of our employees and corporate officers. S corporations are a bit more unique with federal taxes because they pass on their corporate taxes to their shareholders. These shareholders have to report this financial distribution as income on their personal tax returns and pay based on their total income level.
However, an S corporation officer like a President or any of the executive board members is considered an employee. That means any payments they receive are wages and must meet the definition of “reasonable compensation” set by the IRS and current market trends. At Green Valley Tax Services we can help you with essential amounts you need to pay as fair wages to these officers that are comparable to the services being rendered.
How to Find that “Reasonable” Wage Level
The real challenge to developing a reasonable wage is not your company profit level, but the current comparable environment for the officer role inside your S corporation. The IRS suggests you look at:
- 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 companies pay for similar services
- Compensation agreements
- The use of a formula to determine compensation
The easier way to do this is to dig into the current income levels of your competitors and the job roles you share in common. This is not industrial espionage or illegal at all. You can use websites like Salary.com or Glassdoor.com to check how much other S corporations are paying their officer wages. This gives you a decent starting point for your own level of compensation.
Keep in mind that if you pay any health or accident insurance premiums for these officers, they are included as taxable wages as well. The IRS does take a closer look at any “more than 2% shareholders” to see if they are being appropriately compensated. Don’t forget that you are allowed to deduct these insurance premiums just like you would any other employee expense.
Preparing Your S Corporation Wage Taxes
When you do prepare everything for filing or sending to your financial advisor/bookkeeper, we strongly encourage you to maintain a clear record or documentation that supports the level of payment or nonpayment to the S corporation employee or shareholder. This can include the type of work performed, hours of work given, or contribution of other services.
For the most part, this information is most critical for those S corporations earning more than $500,000 annually but is an excellent practice to start from the beginning as you build a corporate financial history for future investments. Not to mention it helps you avoid any sticky situations in case of an audit.
Where to Get Started
If you need help navigating how to formulate reasonable compensation for your S corporation shareholders and officers, start by giving us a call. At Green Valley Tax Services, we have direct experience preparing and planning ahead for S corporations, especially during tax season. We can walk you through the process and help you get ahead so this doesn’t become an issue when you fire, hire or acquire a new shareholder.
Give us a call today or visit our online website to schedule a consultation. Our expert and professional team of tax accountants, bookkeepers, and advisors are ready to help you.