What Is Reasonable Compensation?
Reasonable compensation is a term you may want to be familiar with when valuing your company. As business owners, we have the privilege and responsibility of setting our own wages. How much we take impacts the profits we report on our financial statements.
The health of our financial statements impacts all the dealings we have with third parties, including lenders, potential buyers, and vendors. If we overpay ourselves, it can lower the value of the business, and if we underpay ourselves, it can inflate our business’s value.
In the U.S., the term reasonable compensation is related to payroll tax issues because distributions are not taxed and wages are. The Internal Revenue Service has published a fact sheet that provides factors for determining reasonable compensation that may be useful for Canadian businesses that are wrestling with this issue. Some of these factors include employee training, experience, duties, time spent working in the business, and many other factors.
In the case of a charity, reasonable compensation for executives is even more important. If the executive is overpaid, the CRA could determine there is an undue private benefit and levy penalties. If a charity CEO is considered overpaid, it can’t be good for donations.
There are many twists and turns to reasonable compensation. If it’s an issue or concern for your business, please feel free to reach out and let us know how we can help.