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Reasonable Compensation Determination

Reasonable Compensation Determination

As your tax and financial advisors, DRDA wants to make you aware of your responsibility to accurately determine and document your Reasonable Compensation for the services you provide to your business. Reasonable Compensation is the salary or wages that you, a shareholder-employee of an S Corp, or LLC, pay yourself for the work you perform for your company.

We are here to assist you with this issue and have tools available that can help you accurately determine your Reasonable Compensation figure.

Please complete a contact request form or call us at your convenience so we can discuss this issue further or to get your Reasonable Compensation Report ordered today.

What is a Reasonable Compensation Report?

A Reasonable Compensation Report is a detailed report that establishes your Reasonable Compensation using criteria outlined by the IRS. To generate a Reasonable Compensation report you complete a short on-line interview (15-20 minutes). Once complete, we can go over the report with you and make any needed changes before locking in your Reasonable Compensation figure.

Why do I need a Reasonable Compensation Report?

The IRS requires that all shareholders of S Corps who perform services for their company pay themselves Reasonable Compensation, and it should be paid prior to taking any distributions. There are two ways to think about Reasonable Compensation:

  1. Replacement Cost: What would it cost your company to pay someone else to provide all the services you currently provide?
  2. Fair Market Value: What would other businesses in your community pay you for the services you currently provide to your company?


The key to establishing reasonable compensation is determining what you do for your S Corp. In addition to direct generation of revenue, you should also compensate yourself for administrative work. It is important that you research and document how you reach your Reasonable Compensation figure. See "How It Works” for more information on the Methodology: Summary of Techniques Used to Estimate Reasonable Compensation.


When is the best time to establish your Reasonable Compensation figure?

The best time to establish your Reasonable Compensation figure is now, before an IRS examination. Reasonable Compensation has become an IRS hot button and we have been told to expect an increase in examinations of S Corps (examinations up 33 percent for 2011 to 2012). Completing a Reasonable Compensation Report is easy and provides a defensible position to an IRS challenge.

DRDA, PLLC recommends incorporating the results of this report into the Corporate Minutes of your S-Corporation. See “Forms” for Sample Language for Your Corporate Minutes.

Why is DRDA offering this service?

Protection for Our Clients

Create a Defensible Position

S Corp owners do not make it their business to keep abreast of IRS rules, regulations and trends. That is what they engage their Tax and Financial advisors to do for them. S Corp owners rely on their Tax or Financial advisor to keep them out of harm’s way. Helping our clients research and document their Reasonable Compensation figure each year will provide our clients with the best possible defense should a Reasonable Compensation challenge come their way. For more IRS Information see “Resources” tab.

Add an Additional Layer of Defensibility

Once a client has researched and documented their Reasonable Compensation figure, it is a good practice to add that research and documentation to the corporate minutes. In the words of one IRS examiner with 30+ years’ experience:

“One of the first things an examiner does during an audit is ask to see the corporate minute book. If the examiner sees that the taxpayer took the time to best determine what shareholders should be paid, the examiner would indicate this in their lead sheet of audit issues and not continue to pursue this issue.”

See “Forms” for Sample Language for Your Corporate Minutes.

What are other ways Reasonable Compensation Reports Can Help?

A Reasonable Compensation Report can help our clients on a host of other issues that may come and go throughout the lifetime of their business:

Entity Planning: Knowing what our client’s Reasonable Compensation figure is will play a large role in what entity we recommend.

Valuation: Owner’s and Key Management’s Reasonable Compensation figure prominently into the valuation of a business.

ESOP: If Owners or Former Owners compensation is too high it can cause serious repercussion.

Divorce: An unfortunate event but one that almost always triggers a need to determine Reasonable Compensation for the business owner.

Other Employee Compensation: This tool can also be used to develop rational salary levels for other non-owner employees of your company.