Owner Deferred Compensation

Owners and operators of C-corporations can have effective diversification of compensation planning by utilizing a deferred owner compensation plan. Deferring owner compensation amounts simply to this: “reasonable” payments in owner compensation are fully tax deductible from the C-corp, giving them the ability to avoid the standard double tax. When the good times roll in and the company becomes profitable, many business owners wish they could pay themselves above and beyond what would be considered “reasonable” by the IRS. Unfortunately, by the time the profits begin to pour in, the time has passed for deferring compensation and the double tax is due.

Plan Ahead in the Lean Years

C-corporation owners, especially those who operate services or time-intensive “toiler” businesses, generally experience a dearth in the early years when the business is young. During this time, the owners often take a discounted, meager or non-existent salary. Planning ahead during times of lean helps to shield against taxes when profitability improves.

Entrepreneurs can plan ahead by setting compensation levels above what the business can afford to pay, thus “kicking the compensation can down the road” a few more years. The accruals of owner compensation can then kick in when profit improves. Thus, when the business is kicking out a steady cash flow, the entrepreneurs are able to be paid a regular salary as well as receive the accrued, but unpaid salaries from previous years.

Reducing Reasonable Compensation Risk and Corporate Tax

Avoiding tax when selling your business is part of what we do. And unless you plan on converting from a C-corp to an S-corp — which can be arduous — there are always double taxation issues with which owners will need to deal. Your business sale represents a huge liquidity inflow and probably your most taxable event ever. By siphoning cash out of the business in a prudent way prior to the business sale, owners can save on taxes before and after the liquidity event hits.

In fact, this is an excellent way to avoid keeping too much in retained earnings or taking money out of the company regularly for double taxation hits. When the company finally does sell, it means the cash being kicked out in previous years isn’t either left in the business providing no benefit or is not double taxed as it is taken out when times are good and the IRS doesn’t wish to go after you for reasonable compensation issues.

How Deferred Compensation Interacts With Business Value

One aspect of deferred compensation that owners frequently overlook is its effect on the business’s reported financials — and therefore on its valuation when the time comes to sell. Accrued but unpaid compensation appears as a liability on the balance sheet, which reduces book value. Buyers and their advisors will want to understand the nature of this liability: whether it represents a genuine obligation to the owner, how it will be handled at closing, and whether the amounts are commercially defensible as “reasonable” compensation.

This is why the deferred compensation strategy works best when it is documented from the beginning — through board resolutions, properly structured employment agreements, and annual accrual entries that are clearly supported. Informally tracked accruals discovered late in a due diligence process create uncertainty for buyers and can compress the final purchase price.

For owners planning a future exit, making the balance sheet legible to outside buyers is part of sell-side preparation. That includes normalizing any owner-specific compensation adjustments — deferred accruals, personal expenses run through the business, and below-market salaries — so that adjusted EBITDA reflects the true earnings power available to an acquirer.

The Timing Question: When to Begin Planning

The core lesson of the deferred compensation strategy is that the planning window opens early and closes early. Once a C-corp is generating strong, consistent profits, the IRS “reasonable compensation” benchmark becomes a binding constraint. Paying an owner $800,000 per year from a business that previously compensated them at $150,000 will attract scrutiny — not because the higher amount is inherently unreasonable, but because it is inconsistent with the history of the business.

The ideal time to establish the accrual structure is during the startup or early growth phase, when the business genuinely cannot afford to pay full market compensation. At that point, documenting a compensation obligation that builds over time is commercially rational and defensible. Owners who missed this window still have options — including equity recapitalization structures or other pre-sale planning strategies — but they are generally more complex and less tax-efficient.

Owners dealing with health or age-related transitions that accelerate exit timelines will find that compensation structure choices made years earlier have an outsized effect on net proceeds. The articles on owner health issues in M&A and owner age impact on mergers and acquisitions cover these dynamics in detail.

Coordination With Other Pre-Sale Tax Strategies

Deferred compensation is one tool in a broader pre-sale tax planning toolkit. Other commonly used approaches for C-corp owners include:

• Qualified small business stock (QSBS) exclusions — available to original shareholders in eligible C-corps, this provision can exclude a significant portion of gain from federal tax at sale.
• Installment sales — spreading the receipt of proceeds over multiple years to manage annual taxable income.
• Charitable remainder trusts — transferring appreciated business interests into a trust before sale to defer and potentially reduce capital gains exposure.
• Pre-sale bonuses and distributions — distributing retained earnings or paying deductible bonuses before closing to reduce the taxable asset base being sold.

Each of these strategies has its own eligibility criteria, timing constraints, and interaction effects with the others. The compensation equity transfer is another mechanism owners sometimes use to shift value to key employees or family members; the article on compensation equity transfers explains how these arrangements work alongside broader exit planning.

For owners beginning to think seriously about a business sale, understanding the interplay between compensation structure and transaction proceeds is one of the highest-leverage planning activities available. Our transaction preparation process is designed to help owners work through these questions systematically, well before a buyer is at the table.

Frequently Asked Questions

What does the IRS consider “reasonable” compensation for a C-corp owner?

The IRS evaluates reasonableness based on what an unrelated employer would pay for the same services in the same market. Relevant factors include the owner’s role, the size and complexity of the business, comparable compensation at similar companies, and the history of compensation at that business. There is no fixed dollar threshold — the standard is facts-and-circumstances based, which is why documentation and consistency matter so much.

Can an S-corp owner use a similar deferred compensation strategy?

S-corp owners face a different set of constraints. Because S-corp income flows through to individual returns, the double-taxation concern that motivates the C-corp deferred compensation strategy does not apply in the same way. S-corp owners have their own set of compensation planning considerations, including the requirement to pay a “reasonable salary” before taking distributions, but the specific mechanics of deferred accruals differ materially from the C-corp context.

How does accrued deferred compensation affect the purchase price in an M&A transaction?

Accrued deferred compensation is typically treated as a debt-like item in the deal structure — meaning it reduces the equity value received by the seller at closing, either through a purchase price adjustment or a closing condition requiring the obligation to be satisfied. Buyers will want to understand whether the obligation will be paid off at closing or assumed, and how it has been accrued and documented. This is a routine due diligence item, but one that can create friction if it surfaces late in the process without prior documentation.