Reasonable Compensation For S Corporation Shareholders

A continued "hot topic" for the IRS is whether owners in S corporations are receiving reasonable compensation for the services they are providing to the Company. Accordingly, all S corporation returns are processed by the same IRS service center so that specific items in the tax return can be analyzed such as officer compensation and shareholder distributions. There are no written guidelines as what constitutes reasonable compensation and until recently, a taxpayer had never lost a case where some amount of officer compensation was paid. One recommendation is to use industry guidelines as a basis for what may be considered reasonable compensation. Future legislation may mandate officer compensation or that all earnings of the S corporation are subject to FICA taxes. Other considerations should be taken into account when establishing officer compensation. One consideration is that Social Security retirement benefits are based on the average amount of your earnings taxed for Social Security purposes during your 35 highest-earning years. If you report earnings for less than 35 years, a ZERO will be averaged into the calculation. Likewise, retirement plan contributions are based on wages. Therefore, you should keep this in mind when weighing reductions in current taxes vs. future retirement benefits.