Understanding Reasonable Compensation for Closely Held Business Owners: IRS Scrutiny and Tax Implications
By
Michael Zahrt
Summary
This article discusses the tax implications of compensation planning for owners of closely held businesses. It explains that while businesses can deduct "reasonable" compensation paid to owner-employees, the IRS may reclassify excessive compensation as dividends. The piece outlines factors the IRS uses to determine reasonableness, including the employee's role, comparable market compensation, company financial performance, and compensation history. It warns that misclassification can lead to double taxation and advises business owners to document their compensation rationale carefully.
Source
bskyUnderstanding Reasonable Compensation for Closely Held Business Owners: IRS Scrutiny and Tax Implicationsjdsupra.comKey quotes
· 3 pulledFor owners of closely held businesses, compensation planning is more than just a business decision—it's a tax strategy that can invite IRS scrutiny and the recharacterization of compensation if not handled carefully.
When compensation is considered too high, the IRS can reclassify the excess as a dividend.
The individual may benefit from lower dividend tax rates, but the company loses the deduction.
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