Courts Give Guidance on Reasonable Compensation for S Corporation Shareholders

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While S corporation shareholder-employees would generally rather take distributions instead of salary to minimize payroll taxes, the Internal Revenue Service requires them to take "reasonable" compensation. However, the definition of “reasonable” has been in dispute since the creation of the S corporation rules, and it has rested on the courts to define this term on a case by case basis. 

Two recent court cases provide much-needed guidance on the issue of how much is enough when it comes to S corporation shareholder compensation. In late 2010, an Iowa district court decided Watson, a reasonable compensation case that, together with the North Dakota District Court’s 2006 decision in JD & Associates, provides the direction tax advisers have been seeking. Watson and JD & Associates shed much-needed light on the methodology the IRS and the courts use to determine reasonable compensation in the S corporation arena, providing an analytical approach tax advisers can follow when guiding their clients.

A detailed analysis of the new guidance can be found in this informative Journal of Accountancy article here.

Please contact our office if you would like us to perform an analysis of your s corporation compensation in light of these new rulings.

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