IRS continues to challenge compensation paid to S corporation shareholder-employees that is not considered reasonable

November 2012


Over the years, the IRS has increased its focus on the issue of inadequate compensation by emphasizing through revenue rulings, form instructions, fact sheets, and other guidance that S corporations cannot avoid paying federal employment taxes by characterizing the income earned by shareholder-employees as distributions instead of compensation for services.  Furthermore, as evidenced by recent case law, the IRS continues to be willing to go to court over the issue when the amount of compensation paid to shareholder-employees is not considered 'reasonable' in light of the surrounding facts and circumstances.  Accordingly, S corporations should strive to ensure that their shareholder-employees are receiving compensation that is commensurate with the services being rendered.

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