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Compensation Optimization

Using compensation optimization, business owners can determine if they would benefit from an entity change by considering their total “compensation” needs and how to best distribute that compensation across various types of income.

Commonly referred to as business owner compensation

Do I Qualify for the Compensation Optimization?

Using compensation optimization, you can determine whether changing business entities would have tax benefits for your company, yourself and your total compensation.

2022 Compensation Optimization Details

Compensation optimization is the process of reviewing your total “compensation” needs and determining whether changing business entities would help better distribute the compensation across various types of income. Certain entity types will have owner or shareholder compensation requirements that are dictated by the facts and circumstances of the business and what the taxpayer's personal income needs are currently.

Schedule C: Owners are generally free to take cash out of the business at their discretion without further tax consequences and are not required to pay themselves a salary via payroll.

Partnership: Partners are generally free to take distributions of their share of partnership profits without further tax consequences. Partners cannot pay themselves salaries via payroll, but they can provide for “guaranteed payments,” which are distributions that are not determined by the partnership’s income or their proportionate share.

S corporations: Distributions paid out of an S corporation are not subject to self-employment tax. As a result, Congress added the requirement that owners who work for the corporation pay themselves “reasonable compensation” via payroll, subjecting those wages to payroll taxes at both the company and individual levels.

C corporations: Dividends are not subject to self-employment or payroll taxes. However, they are also not deductible from the taxable income of the corporation. On the other hand, salaries paid to shareholder-employees are subject to payroll taxes, but they are deductible in calculating the corporation’s taxable income. C corporation owners must take a “reasonable salary” to avoid large deductions.

Compensation Optimization

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Learn how Prosperity Tax Advisors can help you save money in taxes.


• Can increase your tax savings.
• Can increase entity tax savings.


• Entity change may be costly.
• If electing to change from an S corporation, will be limited for three years from electing that status again.

Assumptions When Taking the Compensation Optimization

• None noted.

Conflicting Strategies

• None noted.

Requirements to Claim the Compensation Optimization

• Generally, no compensation amounts are required with a Schedule C or partnership. If the partnership makes (or would make if elected) guaranteed payments to the partner for services to the partnership, those payment amounts should be included.

• An S corporation is required to pay an owner-employee reasonable compensation in the form of W-2 wages, and the salary amount will be needed for current S corporations. Taxpayers looking to compare their current entity to an S corporation will need to include an amount of W-2 wages that would be paid to the owner-employee if the business took that form.

• A C corporation will typically pay an owner-employee a salary (W-2 wages). As salary cannot be excessive, it is also highly likely that a C corporation will pay dividends to shareholders, even those who receive a salary. A user should enter total dividends paid out as ordinary dividends and then also indicate what portion of those dividends are qualified dividends.

Business Entities That Can Claim the Compensation Optimization

• Schedule C
• S Corporation
• C Corporation
• Partnership

The material discussed on this page is meant for general illustration and/or informational purposes only and is not to be construed as investment, tax, or legal advice. You must exercise your own independent professional judgment, recognizing that advice should not be based on unreasonable factual or legal assumptions or unreasonably rely upon representations of the client or others. Further, any advice you provide in connection with tax return preparation must comply in full with the requirements of IRS Circular 230.

Prosperity Tax Advisors
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