It’s Your Salary!

It's your Salary! Reasonable Compensation-mand and woman looking at paycheck

It’s Your Salary so who decides how much your paycheck should be? You or the IRS?

You are the business owner. Are you taking advantage of your S Corporation status? Who decides what your salary should be? Don’t let the IRS determine what your salary is. You likely formed an S corporation to save on self-employment taxes.

Consider this – is your S corporation salary nonexistent? Is it too low, too high or, just right? Getting the S corporation salary right is essential.

Suppose it’s too low, and you get caught by the IRS. You will pay income taxes and self-employment taxes on the too-low amount and payroll and income tax penalties that will cost you big time. Then, in most cases, the IRS will expand the audit to cover three years and then add the income and penalties for those three years.

Once the IRS discovers your infraction, you likely are now stuck with this higher salary, defeating your original purpose of saving on self-employment taxes.

What exactly is Reasonable Compensation?

Reasonable compensation is the value that would ordinarily be paid for like services by like enterprises under like circumstances. Reasonableness is determined based on all the facts and circumstances. Or it is the reasonableness of an employee’s compensation by comparing the employee’s salary with the salary of employees performing similar duties at similar companies

There are three methods of determining reasonable comp for the owners of small businesses:
  1. The Cost approach, aka many hats, approach: Generally, works best for small businesses where the owner wears multiple hats.
  2. The Market approach, aka the industry comparison approach: This often works best for businesses where the owner performs predominantly managerial tasks.
  3. The Income approach, aka the independent investors’ test: Generally, works best for outliers.

Confused? It can be tough to make this determination on your own. It’s your salary… you need to understand the tax ramifications.

Let’s set up a time to discuss how reasonable comp affects you. Call Marissa at 772-337-1040 to set up a phone call or a zoom meeting today. Let’s get your financial house in order so you won’t have to pay the IRS more in taxes than you should.

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