S Corp Reasonable Compensation Basics

S corporation tax planning often focuses on distributions, but owner payroll comes first. If an owner works in the business, the company generally needs to pay reasonable compensation before treating remaining profits as distributions.

Reasonable compensation is facts-based

There is no single salary that works for every S corp. The analysis should consider the owner's duties, time worked, revenue, profit, industry, experience, location, staff support, and what the business would pay someone else to perform the same role.

Payroll should be set before year-end

Waiting until tax preparation to think about payroll can create problems. Owner wages, payroll tax deposits, retirement contributions, and year-end forms all need time to be handled correctly.

Distributions are not a payroll substitute

Distributions can be part of S corp cash flow, but they do not replace wages for an owner-employee. A clean plan separates salary, reimbursements, draws, and profit distributions in the books.

Document the decision

A reasonable compensation file does not need to be complicated, but it should show how the salary was chosen. Notes on duties, comparable pay, hours, profit, and business facts are better than guessing once and hoping it holds up.

Source and caveat

The IRS says S corporations must pay reasonable compensation to shareholder-employees for services before non-wage distributions are made. Review current IRS guidance on S corporation compensation. This article is general information, not tax advice for your specific facts.