Reasonable Compensation in S-Corporations: The Rule Most Small Business Owners Get Wrong
5/8/20241 min read
Reasonable Compensation in S-Corporations: The Rule Most Small Business Owners Get Wrong
Introduction:
Many small business owners choose the S-Corporation structure to save on self-employment taxes, but the most common mistake is misunderstanding the IRS requirement for “reasonable compensation.” Incorrectly calculating or underreporting your salary can trigger audits, penalties, and lost deductions.
What is Reasonable Compensation?
Reasonable compensation is the salary an S-Corp owner must pay themselves for services rendered before taking distributions. The IRS expects compensation to reflect fair market value for your role.
Why Small Business Owners Fail
Paying themselves only through distributions.
Using inconsistent or undocumented salary calculations.
Lack of knowledge of IRS guidelines.
How to Calculate Reasonable Compensation
Analyze the market rate for similar positions.
Consider your time and responsibilities.
Document your calculations and decisions.
Examples:
If your role as CEO of a small S-Corp is valued at $70,000 annually, paying yourself only $20,000 in salary and taking $50,000 as dividends may trigger IRS scrutiny.
Benefits of Compliance
Avoid IRS penalties and audits.
Maximize tax deductions legally.
Maintain credibility with banks and investors.
For further information, visit the IRS website “Wage Compensation for S Corporation Officers” (FS‑2008‑25, Agosto de 2008)