As we move into the final quarter of the year, it’s the perfect time for S Corporation owners to revisit one critical area of compliance: reasonable compensation.
Why It Matters
The IRS requires S-Corp shareholder-employees who perform services for the company to pay themselves a “reasonable” salary before taking distributions. This salary must be reported on a W-2 and is subject to payroll taxes. If you're paying yourself too little — or nothing at all — the IRS may reclassify your distributions as wages, potentially hitting you with back taxes, penalties, and interest.
What Is "Reasonable"?
There’s no one-size-fits-all answer, but the IRS looks at several factors, including:
- Your role and responsibilities in the business
- Industry standards and comparable salaries
- Business profitability
- Time spent working in the business
What You Should Do Now
- Evaluate your current salary against others in similar roles.
- Document how you determined your compensation.
- Adjust your salary before year-end if necessary to ensure compliance and avoid surprises at tax time.
If you’re unsure whether your current compensation meets the IRS standard, this is a great time to schedule a review. Small adjustments now can help you avoid major issues later.