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S Corporation Reasonable Salary Analysis

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S Corporation Reasonable Salary Analysis

 

Determining a reasonable salary is the hardest part of running an S corporation. What the heck do I pay yourself?  The IRS requires the officers of an S Corporation, with material participation to be paid a “Reasonable Salary”.  What is a “Reasonable Salary” by IRS standards?  The IRS does not provide a clear-cut answer, they just provide examples that the taxpayer is required to interpret. 

There is no easy answer but there are a few theories that will help us make a determination one way or the other;

How Much Is the Taxpayer’s Labor a Material Income Producing Factor

The more your business is tied to you and the business “Material Income Factor” the higher your salary will likely need to be, within reason.  In other words, if something should happen to you, you are the business and it would likely die with you.

Return of Capital

Conversely, there might be times where your business would continue without you. In a business like this, the business is said to have “Goodwill”.  There are two types of goodwill, enterprise and personal.  Enterprise goodwill is the cash flow derived from tangible assets (cash, equipment, etc.) and is income produced by the business.  Personal goodwill is derived from the officer personal participation.  Therefore, the smaller the personal goodwill, the greater the argument for a smaller salary.

 

 

 

 

 

 

 

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