Categories: Business BasicsHiring/Managing Employees

Reasonable Compensation

This week we are looking at reasonable compensation, a legal necessity for anyone running a Corporation. Reasonable compensation is connected to one of the most fundamental parts of working for a company – getting paid – and yet it’s so widely misunderstood. When you form an Corporation, you create a separate, legal entity that ‘earns’ money. You then pull your wage from those earnings and pay whatever payroll taxes you owe.

In order to close a loophole wherein those running the corporation could ask for an extremely low salary, pay next to no payroll taxes, and then close the wage gap with distributions, the IRS requires that all corporate officers and executive be paid ‘reasonable compensation.’ But what constitutes reasonable compensation is a little more murky.

Who needs to be concerned with reasonable compensation?

Anyone that is runs, or helps run, a C-Corporation or S-Corporation must be reasonably compensated for their work.Now if an officer performs ‘no services or only minor services,’ they are not technically an employee. But for the most part, anyone involved with running the company has to earn a wage, and that wage has to be set at a level that pleases the IRS.

What are the rules for reasonable compensation?

This is where everything gets tricky. There are no hard and fast rules for reasonable compensation – the IRS doesn’t want to be involved in setting limits on executive pay. However, they do say that whatever you are payed should ‘commensurate with your duties.’ Most financial advisors and accountants believe the IRS looks at C-Corporations for overpayment and S-Corporations for underpayment.

So how do you determine what your own reasonable compensation is?

It is generally accepted that the IRS normally looks at what people in similar positions and areas are earning, and bases their expectation for reasonable compensation on those wages. So a small business owner in rural Kansas that recently incorporated his company shouldn’t be pulling the same wage as a New York-based executive of some multi-national firm. You should also factor in the time you spend running the company, how vital you are to the business’s success, and your career experience. If you truly want to be safe, meet with your accountant and ask them to help you with your wage.

Need help getting incorporated? Have any other questions about reasonable compensation? Give us a call at 1-877-692-6772!

Deborah Sweeney

Deborah Sweeney is an advocate for protecting personal and business assets for business owners and entrepreneurs. With extensive experience in the field of corporate and intellectual property law, Deborah provides insightful commentary on the benefits of incorporation and trademark registration. Education: Deborah received her Juris Doctor and Master of Business Administration degrees from Pepperdine University, and has served as an adjunct professor at the University of West Los Angeles and San Fernando School of Law in corporate and intellectual property law. Experience: After becoming a partner at LA-based law firm, Michel & Robinson, she became an in-house attorney for MyCorporation, formerly a division in Intuit. She took the company private in 2009 and after 10 years of entrepreneurship sold the company to Deluxe Corporation. Deborah is also well-recognized for her written work online as a contributing writer with some of the top business and entrepreneurial blogging sites including Forbes, Business Insider, SCORE, and Fox Business, among others. Fun facts/Other pursuits: Originally from Southern California, Deborah enjoys spending time with her husband and two sons, Benjamin and Christopher, and practicing Pilates. Deborah believes in the importance of family and credits the entrepreneurial business model for giving her the flexibility to enjoy both a career and motherhood. Deborah, and MyCorporation, have previously been honored by the San Fernando Valley Business Journal’s List of the Valley’s Largest Women-Owned Businesses in 2012. MyCorporation received the Stevie Award for Best Women-Owned Business in 2011.