What Is Reasonable Compensation to Pay Yourself Through Your S Corporation?

by | May 20, 2022 | Financial Advice, Insights To Business, Small Business Cash Flow

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When you are an owner of a corporation, you can get paid in a variety of ways. It’s important to know which type of pay is best and what type of compensation you deserve for all of the work you do. Determining your level of compensation requires the consideration of many factors. The IRS plays a role by helping to identify what operational tasks were performed by the owner or shareholder and how that helped accrue the company’s gross income.

What is an S Corporation?

In order to be an S corporation, the company must be a domestic corporation with owners who are United States citizens. No more than 100 shareholders can be in place at one time and there is a single class of stock. If the company is to become an S corp, all members must agree to the election and sign a form 2553 from the IRS. With an S corp, all of the income, deductions, losses, and credits move through the system and pass on to the owners and shareholders. If the IRS finds out that anything is amiss, such as having one too many shareholders, it will revoke the S Corp election classification.

Reasonable Compensation Factors

The IRS demands that all shareholders of an S corporation receive reasonable compensation for all of the services they perform. The IRS defines reasonable compensation as the amount someone would be paid for performing certain duties in similar situations. If a shareholder offers anything other than monetary assets to the company, they are acting as an employee. In that line of thinking, an employee is required to be paid similar wages for comparable services throughout the industry in question.In order to define reasonable compensation, many of the following are considered:

  • Time requirements
  • Volume of business
  • Complexities of tasks being performed
  • Abilities of the employee
  • Achievements of the employee

Your company’s overall policy in terms of how all employees are compensated. Even if a shareholder only performs minimal work, they are still entitled to reasonable compensation.

When Should You File for an S Corp Election

If your company wants to receive the S corp election all of the owners and shareholders must agree. Once unanimous support is received, then Form 2553 must be filed within two months and 15 days of the start of the tax year. (March 15). If the deadline is met, the election will take place this year. If the deadline is missed, it will begin at the start of the next tax year. You will hear within 60 days if your election has been approved or denied. Becoming an S corporation will allow everyone to receive the compensation you deserve. Compensation will be based on specific factors that relate to all of the employees of the company. In addition to the shareholders receiving the income and deductions, they will also receive the losses and credits. All aspects of the profits and loss are shared equally and in accordance with the company’s guidelines. This process is closely monitored by the IRS.