S Corporation Owners: The Importance of Paying Yourself a Reasonable Compensation
Understanding Reasonable Compensation
As an S Corporation owner, you enjoy unique tax advantages. However, with these benefits come important responsibilities—one of the most essential being the requirement to pay yourself a reasonable compensation for services performed.
What is “Reasonable Compensation”?
The IRS expects S Corporation shareholder-employees to pay themselves a salary that reflects what similar businesses would pay for the same services in the open market. This is known as "reasonable compensation." The purpose is to ensure owners don’t avoid payroll taxes by taking disproportionate distributions instead of a salary.
Distributions Without Wages—Not in Compliance
If you are taking distributions from your S Corporation without paying yourself a wage, you are not in compliance with IRS requirements. The IRS has clearly stated that shareholder-employees must take a reasonable wage before taking any distributions. Distributions are not a substitute for salary and are only appropriate after a reasonable wage has been paid for the work you perform.
Key Factors the IRS Considers:
Duties and responsibilities
Training and experience
Time and effort devoted to the business
Compensation for similar roles in comparable businesses
Use of a structured, documented approach to determine salary
Risks of Failing to Pay a Reasonable Salary
Failure to comply can lead to serious IRS scrutiny, back taxes, penalties, and interest. The IRS can reclassify distributions as wages, resulting in unexpected tax liabilities and possible audits.
Common Misconceptions:
“I don’t need to pay myself if my profits are low.”
Incorrect—compensation should reflect the work performed, not just profits.“I can make up for it with year-end bonuses.”
Incorrect—regular payroll is required, and bonuses don’t substitute for a regular, fair wage.“I can just take distributions instead of a salary.”
Incorrect—taking distributions without first paying yourself a reasonable wage puts you out of compliance and at risk of IRS penalties.
How We Can Help—Act Before Year-End!
Our firm specializes in supporting S Corporation owners with their compliance requirements. If you have not yet reviewed or established your compensation for the year, time is of the essence!
Our Year-End Compliance Service Includes:
Compensation Benchmarking: We’ll help you determine what is “reasonable” for your industry and position.
Payroll Setup & Processing: Ensure you are on track before the year ends.
Documentation: We’ll help you document your compensation approach to satisfy IRS scrutiny.
Take Action Now
Don’t wait until it’s too late!
Contact us as soon as possible to ensure your S Corporation is compliant. Our team of accounting and client relations professionals is ready to assist, giving you peace of mind as year-end approaches.
Remember: If you are taking distributions without paying yourself a reasonable wage, you are not meeting IRS requirements. Let us help you get back on track!
