Tag Archives: Reasonable compensation

S-Corporation – The Real Risk: Reasonable Compensation

Google it or talk to your friend and you’ll hear all kinds of stories about how I saving $xx,xxx by switching to an S-Corp.  I get inquiries from clients or potential clients regularly asking about this.  But as with anything there are pros and cons to every choice and the face value tax savings aren’t always what they are cracked up to be.  Often, for smaller business the additional paperwork and tax filings eat up any tax savings and just open the door to more potential errors.  So there is a time when this makes sense and this article does a pretty good jobs summarizing the most relevant pros & cons.  The big pro?  Potential tax savings.  The big con?  A lot more paperwork.

The article mentions “reasonable compensation” and this is where things get tricky.  The tax saving so many tout with this structure, even for relatively low business incomes (I just saw an article from a client referencing business income of less than $60,000 per year), are predicated on justifying a reasonable compensation for a corporate officer (let’s say you, the owner) level even lower than that.  The IRS has been chasing down the taxpayers on this issue for quite some time and the real risk business owners need to be educated on is that if you can’t justify your “low” salary with good data, that could mean that your tax return is wrong, your business tax return is wrong, and all your employment tax returns along the way are also wrong.  That means penalties and interest, and while the personal tax side of the equation will typically wash out (trading business income for wage income), the additional employment taxes will wipe out any tax savings you thought you had and the related employment tax error and remittance penalties can quickly exceed 50% of the additional employment taxes assessed.

So when someone says, “S-corp is the way to go!  It saved me so much money!”  Check with your CPA about your specific situation, carefully weigh the pros and cons, determine if you have the time, energy and funds to comply with the additional burdens, and only then can you decide if this choice is right for you.