Tips from our tax professionals

Lindsay Jensen, CPA


In recent years, the IRS launched a study to assess the reporting compliance of S corporations. Compensation paid to shareholder-employees arose as a main area of interest. It was found that many of the distributions taken by shareholder officers should actually have been classified as salaries. Since distributions are not subject to payroll taxes, it is enticing for owners to classify their payments as distributions rather than wages (which are subject to payroll taxes like FICA and federal/state unemployment, resulting in a nearly 20% tax consequence on those payments).

As a result, the IRS has taken the stance that distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts represent reasonable compensation for services provided to the corporation. It is important to note that the IRS cannot create compensation or force a shareholder to take money out of the corporation, it can only re-characterize what was actually paid via distributions as wages.


In the next few years the IRS plans to hire 600-700 auditors to assess S corporations’ non-compliance and implement Automated Tax Compliance Programs to help identify red flags for things like Officer Compensation amounts. Given the intense scrutiny over this area, it’s crucial for S corporation owners to determine an appropriate salary each year. To support compensation amounts, should the IRS initiate an examination, S corporations should have a consistent year to year reasonable compensation policy in place and document its reasoning for salary amounts in the corporate minutes.


So, what is an appropriate amount? The courts and IRS have provided the following factors to consider when determining reasonable compensation:


1)      Training and experience

2)      Duties and responsibilities

3)      Time and effort devoted to the business

4)      What comparable businesses pay for similar services

5)      The use of a formula to determine compensation

6)      Payments to non-shareholder employees

7)      Compensation agreements

8)      Timing and manner of paying bonuses to key people

9)      Dividend history


As evidenced by the list, reasonable compensation is not based strictly on revenue or profit but a combination of factors. Think of it as the Fair Market Value of the shareholder’s services. Following are a few examples of how to fairly allocate payments to wages or distributions:


Example 1

Scott Stone owns 100% of Stone Concrete (S Corp). Based on his responsibilities, time devoted to the business, industry comparisons, etc. Scott’s Reasonable Compensation figure was determined to be $74,685.

·         For tax year 20xx Stone Concrete Net Profit = $190,000

·         Scott took $160,000 out of Stone Concrete

·         Scott must categorize $74,685 as wages (Reasonable Compensation) and may treat the remaining $85,315 as distributions


Example 2

Same information as Example 1 except:

·         Stone Concrete’s Net Profit = $23,000

·         Scott took $30,000 out of Stone Concrete

All $30K must be classified as wages since he did not yet fulfill the $74,685 of Reasonable Compensation. None of the $30K is treated as a distribution.


Example 3

Same information as Example 1 except:

·         Stone Concrete Net Profit = $150,000

·         Scott takes $0 out of Stone Concrete

 Scott did not receive any payments from the Company (and the IRS cannot force an owner to take money out) so he has no wages and no distributions.

Tarn Johnson, LTP

Common IRS Scams

If you haven't heard already, thousands of Americans have fallen victim to dubious con-artists looking to steal your money or identity. While most are easy to spot, some are threatening enough to make people act fast without thinking it through. The 3 major fraudulent activities to watch for are:

  • Identity or SSN theft: If you are unable to file a return because the IRS claims you already have, you should reach out to the IRS or one of our offices immediately. 
  • Threatening Phone Calls: Scammers will impersonate the IRS while making high volume cold calls. By making threats to send police and giving little time to pay, these scammers are often successful. Note: The IRS will never call you directly. Communication will always come in the form of an official letter. If you are unsure of whether or not you are dealing with the IRS, contact your local IRS office.  
  • Illegitimate E-mails: Similar to the phone calls, scammers will send e-mails impersonating the IRS and offering a way to find your refund. Do not respond to or click any links from these e-mails. The IRS will not contact you in this way. 

If you have further questions about how to protect yourself, feel free to contact an office of Byzick + Company.