July 20, 2025
The principles of reasonable compensation are tested in various real-world scenarios that can attract IRS attention. Understanding how the IRS applies these rules in specific situations is critical for compliance.
A common misconception is that an S corporation only needs to pay a salary if it is profitable. This is incorrect. The requirement to pay reasonable compensation is triggered by the services performed by the shareholder-employee and any payments they receive, regardless of the company's net income. The "Salary First" Rule is Absolute.
An entity that fails to file Form 2553 on time can request late election relief from the IRS, often under Revenue Procedure 2013-30. This procedure can allow an election to be treated as effective retroactively, sometimes for up to three years and 75 days. However, a critical requirement for this relief is that the entity must have "acted consistently" with its intent to be an S corporation for the entire period in question.
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