What Is Reasonable Compensation for S-Corp Owners?

Kim Bernstein
Apr 16
2 min read

If you’ve elected S-Corp status for your business (or are thinking about it), there’s one phrase you’ll hear over and over again: reasonable compensation.

Reasonable compensation means paying yourself a fair market wage for the work you perform in your business. But what does that actually look like—and how do you get it right?

Let’s break it down so you can stay compliant, avoid red flags, and make the most of your S-Corp election.

Why Reasonable Compensation Matters

S-Corp owners are required to pay themselves a reasonable salary before taking distributions. Why? Because:

✅ Wages are subject to payroll taxes (Social Security & Medicare)

✅ Distributions are not subject to self-employment tax

📌 Translation: The IRS wants to make sure owners aren’t skipping out on employment taxes by taking 100% of their income as tax-free distributions.

What Is Considered ‘Reasonable’?

There’s no one-size-fits-all dollar amount, but the IRS expects your salary to reflect what you’d pay someone else to do your job.

Factors to consider:

Industry standards
Duties and responsibilities
Time and effort devoted to the business
Experience, training, and qualifications
Geographic location
Comparable salaries from similar businesses

✅ Pro Tip: If you’re wearing all the hats—admin, sales, fulfillment, marketing—you should be paying yourself a higher salary that reflects those multiple roles.

How to Determine a Reasonable Salary

Here are a few ways to come up with a defensible number:

📊 Market Research – Use sites like Glassdoor, PayScale, or industry reports to see what others in similar roles earn.

📊 IRS Guidelines – IRS Fact Sheet 2008-25 lists key factors to consider.

📊 Tax Professional Guidance – Work with a tax professional to benchmark your pay based on your revenue, role, and profit margins.

💡 Example: If someone in your position would typically earn $70,000/year in your area, that should be your baseline—even if your S-Corp brings in $200,000 in profit.

📌 Note: You’ll need to set up payroll to withhold and remit employment taxes properly—something your bookkeeper or payroll provider can help you handle.

What Happens If You Don’t Pay Yourself Reasonably?

🚨 Red flag alert: The IRS audits S-Corps that report high profits with little or no officer compensation.

If they determine your pay was unreasonably low:

They may reclassify distributions as wages (plus back taxes and penalties)
You may owe late payroll taxes and interest
It can trigger deeper audits in future years

Salary vs. Distributions: Finding the Right Balance

As an S-Corp owner, you can take a mix of:

W-2 wages (reasonable compensation) – Subject to payroll tax
Distributions – Not subject to self-employment tax, but only after you’ve paid yourself a reasonable salary

💡 Strategy tip: Once you meet your reasonable comp threshold, the rest of your profits can be distributed, often reducing your overall tax burden.

Final Thoughts

Paying yourself “reasonably” isn’t just about checking a compliance box—it’s about protecting your business and optimizing your tax strategy.

Need help determining a reasonable salary or setting up payroll correctly? KB2 Bookkeeping & Tax can help you strike the right balance. Let’s get it right—before the IRS gets curious. 💼💸