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Subchapter C • 162(a) vs dividends • OBBBA 2025 • 162(m) aggregation • 280G • 409A • payroll risk

C Corporation Compensation, Benefits & Payroll Taxes (2025): how to optimize the mix and defend the deduction

C Corps live in a structural tension: the company wants deductible compensation to reduce entity-level tax, while the IRS polices “excess” pay as disguised dividends. In 2025, the landscape is reshaped by OBBBA provisions, tighter executive comp aggregation, evolving equity-comp AMT dynamics, and high-stakes payroll compliance. :contentReference[oaicite:0]{index=0}

Jump to contents Start with the IRS doctrine

Educational overview only — not legal/tax advice.

Contents

  1. The structural conflict: salaries vs dividends
  2. Reasonable compensation doctrine (with the Independent Investor Test)
  3. Strategic bonus architecture and deduction timing
  4. Executive comp limits: 162(m) and change-in-control 280G
  5. Equity compensation: ISOs/NSOs, 83(b), 409A
  6. Fringe benefits where C Corps win
  7. OBBBA 2025: overtime/tips deductions + SALT cap/AMT interactions
  8. Payroll taxes: wage base, FUTA credit reductions, and TFRP

1) The structural conflict: salary deductions vs distributions

Subchapter C creates “two layers” of tax: corporate tax on profits, then shareholder tax on dividends. Compensation is different: wages and bonuses can be deductible under Section 162(a)(1) if they’re for services actually rendered. That deduction is why closely held C Corps often try to “zero out” taxable income—but it is constrained by reasonableness. :contentReference[oaicite:2]{index=2}

Constructive dividend risk (the IRS’ favorite recharacterization)

When pay is excessive or looks like a return on equity (e.g., bonus mirrors ownership percentages or there’s never a dividend), the IRS can treat the “extra” as a nondeductible dividend—creating tax, interest, and penalty exposure at the corporate level. :contentReference[oaicite:3]{index=3}

2) Reasonable compensation: the doctrine that decides your deduction

Courts have long used multi-factor tests (role, comparables, company condition, conflicts, internal consistency), but many cases give special weight to the Independent Investor Test: would an arm’s-length investor be satisfied with the return on equity after paying the disputed comp? If not, your comp plan starts to look like a dividend substitute. :contentReference[oaicite:4]{index=4}

Practical control knob: target ROE

A durable pattern is to set bonuses after ensuring a “reasonable” ROE remains (e.g., 10–15% target), then document performance KPIs and the rationale in board minutes. :contentReference[oaicite:5]{index=5}

Signal to the IRS: modest dividends can help

Even if you minimize dividends, having a consistent dividend policy can support the narrative that comp is for labor and dividends are for capital—an important “facts” lever in litigation. :contentReference[oaicite:6]{index=6}

3) Bonus timing: 461 all-events, the 2.5-month rule, and 267 related-party traps

Amount is only half the game—timing determines which tax year gets the deduction. For accrual-basis C Corps, bonus deductibility depends on the “all-events test” and economic performance. A key planning tool is fixing a year-end bonus pool (even if individual allocations finalize later), but you must also respect the deferred-compensation timing rules. :contentReference[oaicite:7]{index=7}

The 2.5-month rule (and why owners don’t get the grace period)

Bonuses generally need to be paid within 2.5 months after year-end (e.g., by March 15 for calendar-year filers) to avoid being treated as deferred comp. But for >50% shareholder-employees, Section 267 can defer the deduction until the year the owner recognizes income—often forcing closely held C Corps to pay owner bonuses by December 31 to keep the deduction in the current year. :contentReference[oaicite:8]{index=8}

4) Statutory ceilings: 162(m) and 280G

Public companies face hard limits: 162(m) caps deductible comp for covered employees, and recent law expands aggregation across controlled groups—closing the “split comp across subsidiaries” play. Separately, 280G can deny deductions and impose excise taxes on change-in-control packages; private companies may use shareholder approval mechanics to “cleanse” parachute payments. :contentReference[oaicite:9]{index=9}

5) Equity compensation: align incentives, manage AMT and 409A

Employees often prefer ISOs (capital gains potential), while C Corps often prefer NSOs (corporate deduction at exercise). Founders and early employees can use 83(b) elections to shift taxation to grant-date value (strict 30-day deadline). And 409A is the silent killer: discounted options can trigger immediate taxation plus penalties—making defensible valuations essential. :contentReference[oaicite:10]{index=10}

ISOs

Favorable sale treatment if holding periods met, but exercise can create AMT exposure. :contentReference[oaicite:11]{index=11}

NSOs

Ordinary income at exercise + withholding, but corporate deduction generally matches the spread. :contentReference[oaicite:12]{index=12}

409A

Strike price must be ≥ FMV; use safe-harbor valuations to shift the burden to the IRS. :contentReference[oaicite:13]{index=13}

6) Fringe benefits: where C Corps often beat S Corps

A major C Corp advantage is fringe benefits for shareholder-employees: many benefits that are taxable to >2% S Corp owners can be tax-favored in a C Corp. The report highlights HRAs (with nondiscrimination constraints), Section 127 education (including student loan repayment), dependent care assistance, and group-term life coverage design. :contentReference[oaicite:14]{index=14}

Compliance reality check

Benefits planning is only as good as plan documents, eligibility rules, and testing. “Tax-free” benefits become taxable fast if you fail nondiscrimination tests or don’t operate the plan according to written terms. :contentReference[oaicite:15]{index=15}

7) OBBBA 2025: overtime/tips deductions + SALT cap and ISO AMT twist

The report covers new “working American” deductions (overtime premium and tips, with definitions and phase-outs) and notes an important modeling nuance: even if SALT cap relief increases, AMT can disallow SALT deductions—so ISO exercises can still surprise executives in high-tax states. :contentReference[oaicite:16]{index=16}

8) Payroll taxes: the hard-cost layer and personal liability risk

Payroll taxes apply from the first dollar of wages. The 2025 wage base changes the Social Security cap math, and FUTA credit reductions can increase employer costs in certain jurisdictions. Most importantly, payroll withholding is trust money: failure to remit can trigger the Trust Fund Recovery Penalty (TFRP), which can pierce the corporate veil and impose personal liability on responsible persons. :contentReference[oaicite:17]{index=17}

Operational rule

Treat payroll like a bank transfer, not an “accounts payable” item. If cash is tight, cut other spending first—payroll remittance failures are existential because they create personal liability. :contentReference[oaicite:18]{index=18}

Bottom line

In 2025, C Corp comp strategy is less about “how much can we pay?” and more about building a defensible system: ROE-aware comp architecture, contemporaneous board documentation, correct accrual/payment mechanics, disciplined equity plan governance, compliant fringe benefits, and payroll remittance that never misses. :contentReference[oaicite:19]{index=19}

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