Steps to help protect yourself
There’s no simple way to determine what’s reasonable. If the IRS audits your tax return, it will examine the amount that similar companies would pay for comparable services under similar circumstances. Factors that are taken into account include the employee’s duties and the amount of time spent on those duties, as well as the employee’s skills, expertise and compensation history. Other factors that may be reviewed are the complexities of the business and its gross and net income.
There are four steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation:
- Keep compensation in line with what similar businesses are paying their executives (and keep whatever evidence you can get of what others are paying to support what you pay).
- In the minutes of your corporation’s board of directors’ meetings, contemporaneously document the reasons for compensation paid. For example, if compensation is being increased in the current year to make up for earlier years in which it was low, be sure that the minutes reflect this. (Ideally, the minutes for the earlier years should reflect that the compensation paid then was at a reduced rate.) Cite any executive compensation or industry studies that back up your compensation amounts.
- Avoid paying compensation in direct proportion to the stock owned by the corporation’s shareholders. This looks too much like a disguised dividend and will probably be treated as such by the IRS.
- If the business is profitable, pay at least some dividends. This avoids giving the impression that the corporation is trying to pay out all of its profits as compensation.
You can avoid problems and challenges by planning ahead. Contact us if you have questions or concerns about your situation.
© 2023
For more helpful tax and accounting articles, or to sign up for our newsletter, please visit our KKB Insights page. If you have any questions, please contact us.
Coordinating Sec. 179 tax deductions with bonus depreciation
/in Tax/by KKB CPAsThere’s more than one way for businesses to claim depreciation tax deductions. By combining them, you can get optimal tax-saving results. Continue Reading Coordinating Sec. 179 tax deductions with bonus depreciation
Beware of a stealth tax on Social Security benefits
/in Tax/by KKB CPAsMany retirees are surprised to find out that some of their Social Security benefits are hit with federal income tax. Will you be one of them? Here are the rules. Continue Reading Beware of a stealth tax on Social Security benefits
Maximize the QBI deduction before it’s gone
/in Tax/by KKB CPAsThe qualified business income (QBI) deduction is scheduled to disappear after 2025. Congress could extend it, but don’t count on it. Here’s what you need to know to make the most of it while you can. Continue Reading Maximize the QBI deduction before it’s gone