S Corporation Shareholder Compensation

The wages paid to a shareholder of an S Corporation are often a bone of contention between the corporation and the IRS. The corporation, and its shareholder, typically prefer to minimize their aggregate employment tax liability by paying the shareholder relatively low wages. This practice maximizes the percentage of the shareholder’s total yearly income which is derived from the corporation’s net profit. The net profit is reported on the shareholder’s tax return where it is only subject to income tax. The IRS requires S Corporations to pay their shareholders reasonable compensation for services performed for the business, but until recently there was scant guidance on what would be considered reasonable for any given shareholder. The result was that taxpayers and the IRS often ended up in court disputes over the reasonableness of shareholder compensation. Some recent court cases, however, have yielded guidelines for determining adequate compensation, including the shareholder’s training and experience, duties and responsibilities, and time and effort devoted to the business. If you have questions about the adequacy of the compensation your S Corporation is paying its shareholders contact us for an evaluation.