What we handle
The rule and how it is applied
An owner who performs more than minor services for an S corporation is an employee and must receive reasonable compensation before taking distributions. Since Rev. Rul. 74-44, the IRS has treated distributions paid in place of salary as wages subject to employment taxes, penalties and interest. Courts look at training and experience, duties and time spent, what comparable businesses pay for similar services, the company's revenue and the owner's role in generating it.
Reasonable pay also affects other planning. Wages reduce the section 199A qualified business income deduction but count toward its wage limit, retirement contributions are based on W-2 pay, and state unemployment and payroll taxes apply. A documented compensation study protects the position far better than a round number chosen at year end.
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