Articles · Basics · S Corporations and Form 1120-S
Reasonable Compensation for S Corporation Owners
Shareholders who work in an S corporation must be paid reasonable wages before taking distributions. It is one of the most common S corporation issues.
Why the IRS cares
Wages are subject to payroll tax, but S corporation distributions generally are not. Paying a low salary and taking large distributions can therefore reduce payroll tax. The IRS can recharacterize distributions as wages when pay is not reasonable.
What makes pay reasonable
There is no fixed formula or percentage. Relevant factors include training and experience, duties, time worked, what comparable businesses pay, and the company's gross receipts. Courts look at what the person actually does and what similar work costs.
Supporting the figure
Keep evidence such as salary surveys, a description of duties, and the reasoning for the amount chosen. Review the figure each year as the business changes.
Salary also affects other calculations. It reduces qualified business income but can support the W-2 wage limit for the Section 199A deduction, and it sets the base for retirement contributions.
Key takeaways
- Pay reasonable wages before taking distributions.
- Base the amount on duties and market evidence.
- Document the analysis each year.
For general education only, not tax advice. Tax law changes often, so confirm current rules and amounts with primary sources.