Compensation Glossary

Unreasonable Compensation

Unreasonable compensation is a level of compensation for owner-managers that does not meet the requirements of IRC 162(a) for reasonable compensation. This may be either too low a compensation level or too high, depending upon the form of incorporation. In order for the compensation to be considered as a deductible business expense it must (1) be for services rendered and (2) generally be an amount that like enterprises ordinarily would pay for the services under similar circumstances. There are a series of further factors to consider in determining the similarity of the circumstances. Compensation over the maximum leads to the IRS changing wages to a constructive dividend, an action that creates higher corporate taxes plus interest and penalties. In an underpayment situation, the IRS converts pass-through income to wages and charges FICA and Medicare contributions.