Owners of incorporated businesses know that there\u2019s a tax advantage to taking money out of a C corporation as compensation rather than as dividends. The reason: A corporation can deduct the salaries and bonuses that it pays executives, but not dividend payments. Thus, if funds are paid as dividends, they\u2019re taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is only taxed once \u2014 to the employee who receives it.\n\n\n\nHowever, there are limits to how much money you can take out of the corporation this way. Under tax law, compensation can be deducted only to the extent that it\u2019s reasonable. Any unreasonable portion isn\u2019t deductible and, if paid to a shareholder, may be taxed as if it were a dividend. Keep in mind that the IRS is generally more interested in unreasonable compensation payments made to someone \u201crelated\u201d to a corporation, such as a shareholder-employee or a member of a shareholder\u2019s family.\n\n\n\nDetermining reasonable compensation\n\n\n\nThere\u2019s no easy way to determine what\u2019s reasonable. In an audit, the IRS examines the amount that similar companies would pay for comparable services under similar circumstances. Factors that are taken into account include the employee\u2019s duties and the amount of time spent on those duties, as well as the employee\u2019s skills, expertise and compensation history. Other factors that may be reviewed are the complexities of the business and its gross and net income.\n\n\n\nThere are some steps you can take to make it more likely that the compensation you earn will be considered \u201creasonable,\u201d and therefore deductible by your corporation. For example, you can:\n\n\n\nKeep compensation in line with what similar businesses are paying their executives (and keep whatever evidence you can get of what others are paying to support what you pay). In the minutes of your corporation\u2019s board of directors, contemporaneously document the reasons for compensation paid. For example, if compensation is being increased in the current year to make up for earlier years in which it was low, be sure that the minutes reflect this. (Ideally, the minutes for the earlier years should reflect that the compensation paid then was at a reduced rate.) Cite any executive compensation or industry studies that back up your compensation amounts. Avoid paying compensation in direct proportion to the stock owned by the corporation\u2019s shareholders. This looks too much like a disguised dividend and will probably be treated as such by IRS.If the business is profitable, pay at least some dividends. This avoids giving the impression that the corporation is trying to pay out all of its profits as compensation.\n\n\n\nYou can avoid problems and challenges by planning ahead. If you have questions or concerns about your situation, contact us.