The IRS has recently provided guidance regarding owner’s payroll for businesses filling as S-Corporations. This guidance impacts how much owner(s) should take as payroll, which is subject to Social Security and Medicare, and owner’s distributions, which is exempt from Social Security and Medicare.
In two tax-court cases (Label Graphics, Inc. v. Commissioner and Brewer Quality Homes, Inc. v. Commissioner), the courts have determined that owner’s payroll should be more nuanced than a simple percentage of profits. The court applied a mixture of the following criteria to determine if owner’s payroll was sufficient to justify the amount of owner’s distributions:
The following steps should help your S-Corporation comply with the IRS’s interpretation of “Reasonable Compensation” for small business owners: