S-Corps Must Pay Employees Reasonable Compensation or Face Problems

Owners of small businesses who are also employees of that company may face issues with the IRS if they are not paid a reasonable salary. S-corporation status is a popular choice for small business owners because of the liability protection it provides while simultaneously offering tax benefits. If you own an S-corp and are also an employee, however, you may find yourself under scrutiny from the IRS with regard to your compensation.

12 Factors Used By the IRS to Determine the Reasonableness of Employee Compensation

According to IRS rules, an S-corporation must pay employees reasonable compensation in return for the services that are provided to the company. To determine the reasonableness of the compensation you are provided, the IRS will analyze the following factors:

  1. The duties you perform
  2. The volume of business you handle
  3. The type of work and the amount of responsibility you handle
  4. The overall complexity of your business
  5. The time and effort you devote to the business
  6. The company’s timing and manner of paying bonuses to employees
  7. The cost of living where the business is located
  8. Your individual ability and achievements
  9. How your pay compares with the gross and net income of the business
  10. How your pay compares with the distributions made to shareholders
  11. The company’s policy regarding compensation to all employees
  12. Your payment history

After reviewing these factors, the IRS then establishes a range for the reasonableness of salaries. If your compensation does not fall within this range, you may face tax problems.

Compensation is not the only issue that can arise when it comes to S-corp tax problems. S-corporations that have employee shareholders may also face tax problems with regard to the payment of medical premiums. If you are dealing with an IRS tax problem involving your interest in an S-corporation, we encourage you to contact us today at 800.721.7054.