Reasonable Compensation Compliance | Tax Trouble Consulting

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If you are the owner of a Subchapter S Corporation (“S Corp”), and you provide services in your corporation, then you are required by the Internal Revenue Code to take a “reasonable salary.” In fact, a Treasury Inspector General for Tax Administration (“TIGTA”) Report in 2021 directed the IRS to begin turning up the heat on S Corp owners who fail to take a reasonable salary.

The tax savings of having an S Corporation are found by taking as little salary as possible, therefore minimizing the Social Security and Medicare (“FICA”) Taxes on the wages.

But what is “Reasonable Compensation” for an S Corp owner?

According to the IRS, "Reasonable Compensation" refers to the value that would ordinarily be paid for like services by like enterprises under like circumstances. In other words, it is the compensation that an individual would receive for similar services in a comparable business setting. To satisfy IRS requirements, compensation must be both reasonable and for services rendered.

Beyond the IRS guidance, there are a number of cases where the courts have weighed in on this issue. The key takeaway from the cases is that establishing reasonable compensation requires careful consideration of the shareholder employee's qualifications, responsibilities, and services rendered. Arbitrary salary figures without credible research or documentation are unlikely to be considered reasonable by the IRS or the courts. And if reasonable salary is not taken by the taxpayer, then it opens the door for the IRS to create one for the taxpayer.

We can help you create a reasonable compensation review and help you document your level of compensation to meet the reasonableness test. By doing so we can bullet proof your S Corp return, possibly save you thousands of dollars in taxes, and allow you to sleep better at night even though the IRS is increasing its enforcement in this area.