By Jason Watson, CPA
Posted Thursday, November 2, 2023
Calculating reasonable S Corp officer compensation and shareholder salary is like nailing Jell-O to the wall. If you want to eliminate (not just reduce) the risk that the IRS will disagree with your calculations, you can pay out your entire economic benefit from the business in shareholder salaries. That seems silly, right? This would make the S corporation’s efficacy zero. How do we approach this then?
As you go through this chapter, keep two simple things in mind. First, the word reasonable has an antithesis, and can be defined in the negative. In other words, while it is hard to define reasonable, we can confidently define what is unreasonable. Paying $5,000 in shareholder salaries on $100,000 in net business income (profits) for a one-person consultant S Corp is unreasonable. Most people would agree with that sentiment.
One more stab using different words to convey this concept- rather than eclipsing the reasonable threshold, perhaps view determining an S Corp salary as not wanting to trip the unreasonable wire.
To be certain, the IRS and others use the word reasonable, but they too cannot define what is precisely reasonable and then what is precisely not reasonable. While the sparring of reasonable and unreasonable presents as a binary situation with a winner and a loser, it is anything but binary. As such, we are back to hammers, nails and Jell-O.
Second, we encourage you to embrace the fluidity of reasonable shareholder salary. If you like straight lines and clean garages, this will bug you a bit. At the same time, when you always have the option to pitch an argument with reasonable salary calculations, or anything else in life, that puts you in a favorable position. So, you’re saying there’s a chance. Yes! We are!
This is our favorite chapter not because we like Jell-O shots, because we certainly do at any age or life stage, but because it is the most cerebral S Corp topic and the one we get asked about the most.
In this chapter we will review-
- IRS Stats
- IRS Revenue Rulings and Fact Sheet 2008-25
- Tax Court Cases
- Risk Analysis, Investor Perspective
- Assembled Workforce, Developed Process
- Converting from W-2 to 1099 (revisit the risk analysis)
- RCReports, Risk Management Association (RMA), Bureau of Labor Statistics (BLS) and Salary.com
- Rules of Thumb, Jumping Off Point
- Multiple Shareholders, Spouse Salary, and
- Additional Considerations (Section 199A QBI, 401k optimization, etc.)
Here we go!
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