Compensation Essay

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I. Introduction
When the term “salary” comes to mind, people reference employee wages and the taxes paid by both the employee and the employer. However, the term has a slightly different meaning when it comes to payment of business owners. There are many options on how business owners are compensated, but the options are based on the business entity election. Business owners of sole proprietorships and partnerships are not entitled to a real salary; instead they receive profit distributions from business operations. Profits from a partnership are then divvied up based on the ownership percentage of each partner. They are not responsible for paying the FICA tax, but they do need to pay self-employment taxes and quarterly estimated taxes. Business owners of C and S corporations are waged in one of two ways: salaries if they are involved in daily activity or dividends as a shareholder. In addition to receiving a reasonable salary, payment of Social Security and Medicare taxes are anticipatory.
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Reasonable compensation is not allowed to be over the monies received by a shareholder in relation to direct or indirect business involvement. The IRS determines a shareholder’s affiliation by matching up specific job functions to one of three major sources for collecting inflows. The first major source is the services performed by the shareholder (i.e. administrative tasks & daily business tasks) in which require compensation to be awarded from distributed profits. The second and third major sources include acquired profits from non-shareholder employees as well as equipment and capital added to the business. The distributed profits from these sources are indirectly created within the business and are to be distributed as compensation and dividends (S Corporation Compensation and Medical Insurance Issues
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