S-Corp business owners gain access to great tax benefits that can save themselves and their business plenty of money – but these business owners should be careful to prepare themselves for a reasonable compensation challenge. The IRS gives special attention to S-corporations to ensure that owners are being paid reasonable compensation, and the tax penalties for being found in violation can be costly. Depending on how well you prepared for a reasonable compensation challenge, proving your compensation to be reasonable could be simple, or a hard-fought fight to avoid some hefty fines.
Determining Your Reasonable Compensation
The IRS specifies that your compensation should be “At least as much as other businesses would pay for similar services”, meaning that you should be paying yourself as much as you’d expect if you took a similar position under another company. Most business owners have prior experience and knowledge of their industry, so coming to a reasonable conclusion for your own salary is a simple exercise. For the IRS, however, the process is not so straightforward.
During a reasonable compensation challenge, the IRS will independently determine what they believe your reasonable compensation to be. If there is a significant discrepancy between your conclusion and theirs, you may have to pay penalties on the taxes owed, including interest for the time period they determine you were underpaying. This can quickly add up to a scary figure for a small business, but with the right preparation, you can fight the IRS’ determination and avoid these fines.
How You Can Ensure You’re Prepared for a Reasonable Compensation Challenge
Working closely with an experienced business law and tax planning professional is crucial to avoiding trouble when the IRS conducts a reasonable compensation challenge. They should work with you to determine an easily defensible salary for yourself, using information that is backed up by industry data and relevant to how you run your business. Most importantly, the data and conclusions that lead to your determination of reasonable compensation should be recorded and kept on hand in case of a challenge. Backing up your figures with documented evidence will not only show the IRS how you came to a fair conclusion but also save plenty of time and effort in dealing with them. We provide Reasonable Compensation Reports to our clients who want to ensure they are protected from an IRS audit, and without that, you are risking hefty fines and penalties in the event of an audit. Many accountants and tax preparers set the compensation for S-corporation owners to an amount that “feels right”, but feelings won’t pass muster in an audit, only evidence/based documentation that is officially adopted by the S-corporation.
If you’re an S Corp owner who needs help in determining reasonable compensation or dealing with any other corporate tax issues, The Law Offices of Tyler Q. Dahl has the experience necessary to protect yourself and your business. Contact the Law Offices of Tyler Q. Dahl today to see how we can help you.
Dahl Law Group
