ACCOUNTING FOR YOUR MONEY MICHAEL J. RASMUSSEN, CPA
Owners must take care to determine a “reasonable”—
and deductible—compensation for themselves and
By Michael J. Rasmussen
What’s the best way to set my salary from my S corporation
of compensation paid. For example, if compensation is
being increased in the current year to make up for earlier
years in which it was too low, be sure that the minutes
reflect this change and the reason for it.
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 IRS.
•;Keep compensation in line with what similar restaurants
are paying their waitstaff and managers. Hold on to any
supporting evidence that you may acquire in case the IRS
questions you about it later.
If the business is profitable, be sure to pay at least some
dividends. This avoids creating the impression that the
corporation is trying to pay out all of its profits as compensation.
As the owner of an incorporated business, you’re probably
aware that there’s a tax advantage to taking money out of the
corporation as compensation (salary and bonus) rather than
as dividends. The reason is simple: A corporation can deduct
the compensation that it pays, but it can’t deduct dividend
payments. Thus, if funds are withdrawn as dividends, they’re
taxed twice—once to the corporation and once to the recipient. Money paid out as compensation is taxed only once—to
the employee who receives it.
However, there’s a limit on how much money you can take
out of the corporation in this way. The law says that compensation can be deducted only to a reasonable extent. Any unreasonable portion is nondeductible and, if paid to a shareholder,
may be taxed as if it were a dividend. As a practical matter, the
IRS rarely raises the issue of unreasonable compensation unless
the payments are made to someone “related” to the corporation,
such as a shareholder or a member of a shareholder’s family.
How much compensation is considered “reasonable”? There’s
no simple formula. The IRS tries to determine the amount that
similar restaurants would pay for comparable services under
like circumstances. Factors may include the employee’s duties; the amount of time required to perform those duties; the
employee’s abilities and accomplishments; the complexities
of the business; the gross and net income of the business; the
employee’s compensation history; and the corporation’s salary
policy for all of its employees.
There are a number of concrete steps you can take to make it
more likely that the compensation you earn will be considered
“reasonable” and, therefore, deductible by your corporation.
For example, you can:
•;Use the minutes of the corporation’s board of directors to
contemporaneously document the reasons for the amount
Finally, be aware that Form 1120S, Line 7, reports compen-
sation to officers received from your restaurant operations. The
IRS scrutinizes all tax returns that have a zero amount on this
line, and we are told that these returns are frequently selected
for inspection. This may lead to an eventual audit, so make sure
that you have paid yourself a reasonable compensation if you
are the shareholder of your entity.
Michael J. Rasmussen is the owner of Rasmussen Tax Group in
Conway, Arkansas. Visit rasmussentaxgroup.com for additional insight
into restaurant-specific tax strategies and technology programs.