Resources
S corporation reasonable compensation: documenting owner pay
Owner compensation should reflect the work performed for the S corporation. Build a record of duties, time and comparable pay before deciding how wages and shareholder distributions fit together.
Last reviewed:
General information, not legal or tax advice.
Pay for services before making non-wage distributions
The IRS requires reasonable compensation for services provided by a shareholder-employee before non-wage distributions are made to that person. It can reclassify distributions as wages subject to employment taxes. A bookkeeping label by itself does not establish the character of a payment; have your CPA review the proposed compensation arrangement.
Sources: IRS, S Corporation Compensation and Medical Insurance Issues
Trace receipts to the people and assets producing them
The IRS identifies shareholder services, non-shareholder employee services, and capital and equipment as sources of gross receipts. Personal services performed by the shareholder support wage treatment, and administrative work supporting other employees or assets also matters. Describe both client-facing work and management responsibilities rather than considering only billable activity.
Sources: IRS, S Corporation Compensation and Medical Insurance Issues
Build a compensation file from the IRS factors
Relevant factors include training, experience, responsibilities, time devoted to the business, dividend history, comparable compensation, payments to other employees, bonus practices and compensation agreements. Collect evidence about the owner’s actual role and document changes as duties evolve. This guide does not prescribe a salary percentage or a universal wage amount.
Sources: IRS, S Corporation Compensation and Medical Insurance Issues
Review shareholder health insurance with payroll
For a greater-than-2-percent shareholder-employee, the IRS describes health and accident premiums as deductible by the corporation and reportable as wages in W-2 Box 1. Under a plan covering all employees or a class of employees, those premiums are excluded from Boxes 3 and 5. Provide policy and payment records to the CPA before final payroll reporting.
Sources: IRS, S Corporation Compensation and Medical Insurance Issues
Preserve the support behind the payroll entries
IRS recordkeeping guidance requires employment tax records for at least four years after the tax becomes due or is paid, whichever is later. Keep the approved compensation decision, payroll reports and benefit support together. Distinguish payments for services from other owner transfers so the year-end review can follow the decision through the books.
Sources: IRS, How long should I keep records?
Sources: pay for services before making non-wage distributions
Connect owner pay with entity records
Put the approved owner-pay decision into payroll
Tidwell supports payroll records and reconciliations after you and your CPA determine appropriate shareholder compensation and benefit treatment.