There is a lot of misconception on how to pay yourself that Reasonable Compensation when your company is an S-Corp. There is a big struggle to navigate between how much taxes you want to pay and how much you should pay. The struggle to prove to the IRS that the compensation you are paying yourself is reasonable is even bigger.
What is at stake? Well, a lot, actually. First of all, if the IRS determines that your reasonable compensation is low or non-existent, they may reclassify your distributions as reasonable compensation. And then what? And then, you are stuck with the bill for all back payroll taxes, penalties, and interest. If you don’t know what back payroll taxes are it is because those people who had to deal with them, head heart attack and died, and didn’t have time to share what it is. Ok, that’s a joke. Almost a joke.
Did you know that the unpaid payroll taxes penalty alone can destroy your financial state pretty fast?
The 100% penalty can be assessed against a responsible person or several responsible persons.
Back payroll taxes are one of the most serious tax problems a business owner can encounter.
Payroll taxes you owe will not get legally written off (“discharged”) even if you file bankruptcy.
To help you establish how much your reasonable compensation should be, you may want to take these things into account:
- • the employee’s qualifications
- • the nature, extent, and scope of the employee’s duties;
- • the employee’s background and experience;
- • the employee’s knowledge of the business;
- • the size and complexity of the business;
- • the time devoted by the employee to the business;
- • the economic conditions generally and locally;
- • the character and amount of responsibility of the employee;
- • whether or not the compensation is pre-determined based on activities to be performed or not determined until the end of the tax year;
- • amounts paid to the employee in prior years;
- • the salary policy of the taxpayer as to all employees; and
- • the amounts paid by similar size businesses in the same area to equally qualified employees for similar services
Have you bought a notebook to record all this in your S-Corp minutes? I think you should.
Your S-Corp minutes regarding the reasonable compensation should be verifiable, documented, and defensible.
Did you know that job titles claimed for the reasonable compensation should be relevant to jobs performed?
Once you put the “CEO” when you sign your tax return- this is your title and your position in your company.
If you have already signed your tax returns with “CEO” as your position, then, the IRS would be researching how much a CEO in your area, in your position earns on average (in case of an audit).
Did you know that, In some cases, even if a company shows a loss for the year, they may still owe reasonable compensation to their shareholders-employees?