1. What is reasonable compensation for S corporation shareholders?

Reasonable compensation for S corporation shareholders is the amount of salary that a shareholder-employee would receive if they were not an owner of the corporation. It is based on the shareholder-employees job duties, experience, and the prevailing salary rates for similar positions in the same geographic area.

2. Why is reasonable compensation important for S corporation shareholders?

Reasonable compensation is important for S corporation shareholders for several reasons:

• It ensures that the shareholder-employee is paid a fair wage for their work.
• It helps to avoid IRS scrutiny of the corporation’s tax returns.
• It can help to reduce the shareholder-employee’s self-employment tax liability.

3. How is reasonable compensation determined?

The IRS does not provide a specific formula for determining reasonable compensation for S corporation shareholders. However, several factors can be considered, such as:

• The shareholder-employee job duties and responsibilities
• The shareholder-employee experience and qualifications
• The prevailing salary rates for similar positions in the same geographic area
• The corporation’s financial condition
• The shareholder-employee ownership interest in the corporation

4. What are the consequences of paying unreasonable compensation to S corporation shareholders?

If the IRS determines that an S corporation shareholder is being paid unreasonable compensation, the corporation may be subject to additional taxes. Additionally, the shareholder-employee may be subject to self-employment tax on the excess compensation.

5. How can S corporation shareholders ensure they are paid reasonable compensation?

S corporation shareholders can ensure that they are being paid reasonable compensation by:

• Comparing their salary to the prevailing salary rates for similar positions in the same geographic area
• Obtaining an independent appraisal of their job duties and responsibilities
• Documenting the factors that were considered when determining their compensation

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