A small business owner I know jokes that his business card should read “President and Janitor” (and everything in between). So, when my friend tries to determine his reasonable compensation figure (at his accountant’s request), should he be compensated as President? Janitor? Or somewhere in between? Where in between?
That’s the challenge faced by S Corp owners when trying to determine their Reasonable Compensation figure. The IRS guidelines for determining reasonable compensation specifically state that “In addition to the shareholder-employee direct generation of gross receipts, the shareholder-employee should also be compensated for administrative work performed…” In other words, the IRS wants the S Corp owners to pay themselves appropriately for all the duties and responsibilities they provide to their company.
Why is this question so difficult to answer? Because no two small business owners do the same things for their S Corps. Therefore, to get an accurate reasonable compensation figure an S Corp owner requires a unique, custom job profile. Building a custom job profile is a daunting, time-consuming process, which is probably the reason most S Corp owners don’t do it.
Would more small business owners make one if it were easy and quick? Of course, they would. In roughly 20 minutes RCReports can build a custom job profile for a small business owner and calculate an annual salary to match. (Click here to learn more about RCReports)
Or for the do-it-yourself crowd follows these steps:
- Make a complete list of all the services you provide to your S Corp
- Apportion your time among all the services listed
- Rate your level of expertise and experience for each service performed
- Gather wage data on all the services listed and at the appropriate level of expertise
- Assemble all your research and data and calculate your Reasonable Compensation figure
Keep in mind that determining a Reasonable Compensation figure is far from an exact science. It is important that you research and document how you determined your Reasonable Compensation figure, and keep your explanation and all backup documents and reference sources in a place where you can find them when the IRS comes calling. If the IRS challenges your number, you will need a detailed explanation of how you came up with your Reasonable Compensation figure.
