This past week while getting ready for tax season, I had the chance to review some of the changes and requirements for S-Corporations (thanks to the IRS and NSA). One of the most common mistakes that S-Corporations make occurs in the area of owner/employee compensation. Typically owners of S-Corporations are considered employees that must take “reasonable compensation” when they perform services for the S-Corp. Once a reasonable compensation has been established, owner/employees can take additional income from the S-Corp as distributions that will not be subject to employment tax rules.
The main question(s) that arises are what is considered reasonable compensation, and how is that compensation validated. The best way to determine reasonable compensation is to look at what the market pays for similar work performed and possibly reviewing information from the employment section of the newspaper or websites. Structuring your compensation plan with your tax advisor will assist S-Corp owner/employees and ensure that their returns won’t come up for audit. Audits of S-Corps increased in 2006, and by taking the necessary steps owner/employees can have less worries at tax time.
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