Officer Compensation for IRS Purposes and Taxable Income

By | December 5, 2015

is an important topic to cover because many business owners do not realize that corporate officers are employees by statute. For example, corporate officers are employees for FICA purposes under Internal Revenue Code Section 3121(d)(1). Corporate officers are employees for federal income tax withholding purposes under Internal Revenue Code Section 3401(c). Corporate officers are employees for FUTA purposes under the Internal Revenue Code Section 3306(i).


Payments for services as wages

Although the statutes are clear, many offices of S corporations or closely-held C corporations fail to treat payments for services as wages. Instead, they improperly treat the payments as corporate distributions, loans, and payments of personal expenses. I’ll go over some examples of an officer’s compensation being wages.



Officer Compensations, Wages, and Employment Tax

If a corporate officer performs services, their compensation is wages and subject to employment tax. Performance of services is a key factor in determining if these payments are subject to employment tax. The courts have recognized that the president of a corporation generally performs more than minor services and is therefore an employee. Because a corporate officer is an employee by statute, the courts have found, in case after case, that the corporate taxpayer had no reasonable basis for treating a corporate officer as anything other than an employee. When does Section 530 comes into play with respect to officer’s compensation?


Section 530 Relief

The courts have consistently rejected the argument that the corporation is entitled to relief under Section 530 of the Revenue Act of 1978. This is not because Section 530 cannot apply, but because it is not reasonable to treat an officer as a non-employee when the statute clearly states that the officer is an employee. Over the past 25 years, courts in five different circuits, plus the Tax Court, have issued opinions that an officer of a corporation was an employee and that payments to the officer were wages, subject to employment taxes.


Other Officer Compensation Issues

In these cases, where Section 530 was addressed, the court found that the taxpayer was not entitled to relief under that provision. Some case names are on the screen in case you want to refer to them in the future. Marvina, now that we have clearly explained why officer compensation is considered wages, can you tell us how to determine a reasonable salary for officers


Determination of a reasonable salary for Officer

Is there a standard formula? ┬áNo, there’s no magic formula. The determination of a reasonable salary will be different in each case, because it must be based on each specific situation. So the facts and circumstances of each officer and company should be addressed. Some of the key factors will include: position held by each officer, duties performed by each officer, hours worked by each officer, and compensation paid, including bonuses.


What is Reasonable Compensation for a Corporate Officer?

As I said, there is no magic formula for determining reasonable compensation for an officer; however, I understand that there are some websites that can be useful for providing ranges of comparable salaries for many types of businesses in various geographic areas. So where can a corporation find a little help in establishing what reasonable compensation should be? There are several websites that businesses can use as resources to help determine compensation in their fields or geographic locations.

The U.S. Department of Labor, Bureau of Labor Statistics website publishes occupational employment statistics, which include an alphabetical list of occupation from accountants to zoologists. There are also many other useful sites on the internet to help determine reasonable compensation.


Which of the following are factors in determining a reasonable salary for corporate officers?

Please remember that more than one answer may be correct. A, the officer’s lifestyle; B, the scope and extent of the duties the officer performs; C, the Internal Revenue Code provides pay scales for corporate officer compensation; D, the hours the officer works? As has been our practice, please take a few moments to think about your answer.

Factors in Determining Officer Compensation

The correct answers are B and D. A is incorrect because an officer’s lifestyle has no bearing on a reasonable compensation. Reasonable compensation is determined within the framework of the officer’s relationship to the corporation, not how the officer lives a personal lifestyle. B is correct. The actual scope and duties an officer performs are a key factor in determining the reasonable compensation for that officer. The officer’s reasonable compensation should reflect what duties the officer performs. Answer C is incorrect, because, as we have stated, there is no one set way of determining reasonable officer compensation, and the tax code does not provide such guidance. And finally, D is correct. It makes sense that the hours an officer actually spends performing their duties for the corporation are a key factor in determining reasonable officer compensation.