Today’s episode focuses on the concept of reasonable compensation for S-Corp and C-Corp business owners.

Reasonable compensation is often misunderstood, but it is crucial for tax planning and compliance.

The episode highlights the importance of understanding reasonable compensation and provides insights into how to determine it accurately.

The cost approach or “many hats” approach is commonly used.

This approach involves evaluating all tasks performed by the shareholder employee based on a 40-hour workweek or 2,080 hours per year.

Labor statistics for the geographic area are considered to determine compensation for each task.

The total compensation is the sum of various activities performed in the business.

For S-Corp owners, a reasonable salary must be paid, but additional distributions can be taken if there is sufficient basis or equity in the business.

Distributions taken without paying a reasonable salary can be reclassified as payroll, leading to penalties, interest, and payroll taxes.

Keeping the salary too high or too low can have implications, including potential IRS scrutiny.

Paying oneself a reasonable salary affects social security benefits and retirement planning.

Minimizing profits by paying a very low salary can result in reduced social security benefits in the future.

Reasonable compensation serves as retirement and social security funds, ensuring a secure financial future.

If you require assistance with determining reasonable compensation for your S Corp, we offer reasonable compensation studies.