Why Reasonable Compensation Matters
If you're a shareholder-employee in an S corporation, paying yourself a reasonable salary is more than just best practice—it’s a legal requirement. Reasonable Compensation must be paid via W-2before you take any distributions from the business. Skipping this step can lead to penalties, back taxes, and even the loss of your S-Corp status.
This is why we strongly recommend an annual Reasonable Compensation analysis—and here's how it benefits you.
What Is “Reasonable Compensation”?
According to the IRS, it’s the value that would ordinarily be paid for like services by like enterprises under like circumstances (IRS Code: §162-7(b)(3)). In plain terms: What would someone else be paid to do the job you’re doing?
This isn’t based on your business’s profits, how much cash is in the bank, or how little you want to pay yourself. It’s based solely on the value of the services you perform.
Why You Need a Professional Annual Review
Too many S-Corp owners make short-sighted decisions based on minimizing taxes today, instead of protecting their financial future. Here’s why your Reasonable Compensation should be reviewed every year:
✅ IRS Scrutiny Is Real
Failing to pay yourself reasonably while taking distributions invites IRS audits—and penalties.
✅ Wages Change Over Time
Just like the labor market shifts, your responsibilities and business value do, too. What was “reasonable” five years ago may no longer pass muster.
✅ Documentation Is Key
An annual review provides defensible, well-documented support for your compensation—critical if the IRS comes knocking.
✅ Protect Your Benefits
Paying the right wage helps you build Social Security benefits and maximize retirement contributions.
✅ Optimize Tax Strategy
With proper analysis, you can still legally minimize FICA taxes, avoid Medicare surtaxes, and maximize your 20% QBI deduction—all while staying compliant.
How We Determine Reasonable Compensation
We use IRS-approved methods tailored to your business:
Market Approach – Compares to industry benchmarks for similar roles.
Cost Approach – Estimates the replacement cost of your services.
Income Approach – Ties your wage to the profitability and contributions you provide.
We use trusted, unbiased data sources (e.g., Bureau of Labor Statistics) rather than sites with self-reported or inconsistent figures like Glassdoor or Payscale.
Our Reasonable Compensation analyses are built on industry-accepted standards and IRS-compliant methodology to ensure your figures are defensible and well-documented.
What Happens If You Don’t?
Not paying yourself a Reasonable Compensation before taking distributions could result in:
Back taxes and interest
IRS penalties
Loss of your S-Corp status
Audits and exposure for your tax preparer
Stay Compliant and Confident with Expert Compensation Analysis
Let us handle your Reasonable Compensation analysis each year. As part of your strategic tax planning, we’ll help you:
Meet IRS standards
Protect your business from audit risk
Support Social Security and retirement goals
Optimize your QBI deduction and tax efficiency
Ready to protect your business and stay IRS-compliant?
Schedule your Reasonable Compensation Analysis with our team today!