{"id":4606,"date":"2017-04-17T05:51:15","date_gmt":"2017-04-17T12:51:15","guid":{"rendered":"http:\/\/evergreensmallbusiness.com\/?p=4606"},"modified":"2018-10-10T10:57:45","modified_gmt":"2018-10-10T17:57:45","slug":"s-corporation-reasonable-compensation","status":"publish","type":"post","link":"https:\/\/evergreensmallbusiness.com\/s-corporation-reasonable-compensation\/","title":{"rendered":"S Corporation Reasonable Compensation"},"content":{"rendered":"

\"Picture<\/a>Businesses often struggle with the “S corporation reasonable compensation” question.<\/p>\n

Set the number too low and you risk the wrath of the IRS. Set the number too high and you’ll pay more Social Security and Medicare tax than you need.<\/p>\n

In this blog post, therefore, I want to provide you with five tips for setting reasonable S corporation compensation.<\/p>\n

I can\u2019t make any guarantees, but if you follow my tips, it\u2019s unlikely your 1120S return gets selected for an examination. And if your return is selected, I think it\u2019s unlikely you\u2019ve have any serious \u201creasonable compensation\u201d issues in the audit.<\/p>\n

Maybe the best news, though, is that these tips should still let you minimize your payroll taxes.<\/p>\n

S Corporation Reasonable Compensation Tip #1<\/h2>\n

You want to pay yourself more than the IRS reports the average S corporation in your industry pays its typical corporate officer. (I provide a link to a table of these averages we maintain at our S Corporations Explained website at the end of this post.)<\/p>\n

For example, if the Internal Revenue Service\u2019s own statistics report that the mean corporate officer wage for a firm in your industry equals $40,000, you want to pay yourself at least $40,000.<\/p>\n

Note that corporate officers are not necessarily corporate shareholders. However, you will find that an IRS auditor has a tough time arguing a shareholder employee should receive more than the industry average corporate officer salary.<\/p>\n

S Corporation Reasonable Compensation Tip #2<\/h2>\n

A second tip: Find the job within the Bureau of Labor Statistics salary database that most closely matches the actual job you perform. Then pay yourself at least the Bureau of Labor Statistics average for your job. (Start your search here: Overview of BLS Wage Data<\/a>.)<\/p>\n

If you run a construction company, for example, and at the end of the day you\u2019re primarily a construction supervisor, make sure you pay yourself at least the Bureau of Labor Statistics average salary for a construction supervisor.<\/p>\n

You want to use the Bureau of Labor Statistics data rather than something like payscale.com or salary.com for a couple of reasons, by the way. First, the Internal Revenue Service understandably gives more weight to statistics that come from federal government sources.<\/p>\n

A second reason to use the Bureau of Labor Statistics database is that its numbers seem to be more realistic than those that come from salary.com and payscale.com.<\/p>\n

A tangential remark on tips #1 and #2: If the IRS statistics say that the average corporate officer working for an S corporation in your industry makes $38,000 and then the Bureau of Labor Statistics says on average someone doing your job earns $45,000, the IRS has a tough time arguing that a salary of $45,000 is too low.<\/p>\n

S Corporation Reasonable Compensation Tip #3<\/h2>\n

A quick third tip: do look at what your other employees get paid.<\/p>\n

Logically, if you own and operate an S corporation, you probably should be the highest paid employee.<\/p>\n

You probably can\u2019t pay yourself, say, $20,000 a year if your top team members make $90,000. Sorry.<\/p>\n

I may be reaching on this, but I think this reality is one of the subtexts that comes out of the last big S corporation reasonable compensation tax court case, David E. Watson vs Commissioner<\/a><\/i>.<\/p>\n

S Corporation Reasonable Compensation Tip #4<\/h2>\n

As much as you can, pad out shareholder-employee compensation with nontaxable fringe benefits.<\/p>\n

For example, if your S corporation can provide shareholder-employees with health insurance, be sure to do the accounting for that health insurance correctly so it counts as nontaxable fringe benefits that save income taxes, save payroll taxes and reduce shareholder distributions\u2014all while in effect bumping up the total compensation package for a shareholder.<\/p>\n

Just so you understand how powerful this is, assume you have an S corporation that generates exactly $100,000 of profit for a shareholder-employee. If you call $48,000 of this amount wages, that might seem unreasonable if you take the other $52,000 of the profit as a distribution.<\/p>\n

If you use $12,000 of that leftover $52,000 of profit\u00a0to purchase health insurance for the shareholder-employee, however, the tax return reports $60,000 as shareholder wages and that leaves only $40,000 of money available for shareholder distributions.<\/p>\n

By the way, employer matching pension fund contributions work the same way. A $15,000 SEP contribution or 401(k) contribution bumps someone\u2019s compensation package, but without triggering payroll or income taxes.<\/p>\n

Note that $15,000 would be the maximum allowed if someone earned a base salary of $48,000 and then received $12,000 of health insurance. Which means in a case where an S corporation earned $100,000 in profit and paid $48,000 in base wages, $12,000 in health insurance, and $15,000 in pension fund matching, the total compensation package equals $75,000.<\/p>\n

That’s pretty good. And it leaves\u00a0in our example where the total business profit equals $100,000 only $25,000 of funds available for shareholder distributions.<\/p>\n

S Corporation Reasonable Compensation Tip #5<\/h2>\n

My final tip related to S Corporation reasonable compensation\u2026<\/p>\n

You ought to understand that if the IRS concludes you have not paid yourself a reasonable wage, what happens next is the IRS re-classifies shareholder distributions as wages.<\/p>\n

But think about this for a minute\u2026 This reality means that the final thing you may want to do is to minimize distributions to shareholders.<\/p>\n

The easiest way to minimize distributions to shareholders is to leave funds inside the corporation. You might choose to leave your rainy day fund or emergency reserves inside your corporation for example.<\/p>\n

But there are other ways to minimize distributions to shareholders too. For example, you might make charitable contributions you would otherwise make personally from the corporation directly. If you make a $5,000 charitable contribution directly from your S Corporation, that $5,000 is not a distribution and so shouldn\u2019t be vulnerable to re-categorization as wages.<\/p>\n

Related Resources You Might Find Useful<\/h2>\n

Average S Corporation Salaries<\/a> (a resource at our S Corporations Explained website)<\/p>\n

S Corporations, Healthcare and Obamacare<\/a><\/p>\n

Safe Harbor S\u00a0Corporation Salaries<\/a><\/p>\n

Paying Zero S Corporation Shareholder-employee Wages<\/a><\/p>\n

An Ebook You Might Find Useful<\/h2>\n

Need even more information? You might be interested in our ebook on the subject of S corporation salaries. Written in plain, everyday language, our Setting Low Salaries of S Corporations<\/em> ebook\u00a0explains how to save thousands of dollars a year with your S corporation–but at the same time how you can do so ethically and responsibly and in a way that minimizes both the chance that your S corporation tax return will be examined and the chance your S corporation salary will be rejected by the Internal Revenue Service.<\/p>\n

\"\"<\/a>Priced at $100, this ebook should save you thousands of dollars a year in payroll taxes.\u00a0To buy and download the S corporation salaries ebook, click this button:<\/p>\n