Cost Approach

By Paul S. Hamann & Jack Salewski, CPA, CGMA

There are three generally accepted methods for determining reasonable compensation for the owner of a closely-held business. It is important to match each method with the business’s size and business owner’s job duties.

1. The Cost approach, aka many hats, approach: Generally works best for small businesses where the owner wears multiple hats.
2. The Market approach, aka the industry comparison approach: Generally works best for SMB’swhere the owner performs predominantly managerial tasks.
3. The Income approach, aka the independent investors’ test: Generally works best for outliers.

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By Paul S. Hamann & Jack Salewski, CPA, CGMA

The old adage “Simple isn’t always easy” perfectly sums up the IRS and Court guidelines for determining Reasonable Compensation for an S Corp owner.  At first blush the IRS and court guidelines seem simple enough – but once you start to follow the roadmap the IRS and Courts have laid out – something that appears simple quickly turns into a challenge.  Let us explore step by step best practices for determining Reasonable Compensation for a shareholder-employee of an S Corp:

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