The Wealth Strategies Journal has just posted a new article entitled, "The Reasonableness of Owners' Compensation," by Jesse A. Ultz, CFA.
From the article: "Many business owners are motivated to deviate from an arm's-length compensation level for owners in order to minimize taxes paid either at the corporate or individual level. For example, owners of businesses organized as C corporations may be incentivized to pay owners' compensation above that of an arm's-length amount in order to minimize taxes incurred at the corporate level. In contrast, owners of pass-through entities, such as S corporations, may be motivated to pay reduced compensation to owners and instead make distributions to owners in order to avoid payroll taxes. FN1. Given these strategies, the Internal Revenue Service (the "IRS") requires that, to be recognized as a business expense based on §162(a)(1) of the Internal Revenue Code (the "Code"), compensation must be reasonable in amount and must be paid "for personal services actually rendered." Moreover, shareholders of private businesses have the burden of proof when evaluating what is reasonable as it pertains to owners' compensation. Treas. Reg. §1.162-7(b)(3) defines "reasonable" compensation as the amount that "would ordinarily be paid for like services by like enterprises under like circumstances." For any closely held business that has either significant reasonable or actual owners' compensation relative to overall earnings, the adjustment to that of an arm's-length transaction may have a profound impact on the concluded value."
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