Definition
Reasonable compensation is the salary an S-corporation owner-employee must pay themselves for the work they perform, before taking additional profit as distributions.
How It Works
The IRS requires S-corp owners who work in the business to pay themselves a wage comparable to what the role would earn elsewhere. Wages are subject to payroll tax, while distributions are not, so the figure determines how much payroll tax is owed and also affects the QBI deduction.
Example
An S-corp owner doing work worth $130,000 a year pays that as salary and takes the rest of the profit as distributions, rather than paying themselves a token wage.
Who It Applies To
S-corporation owner-employees.
Watch-Outs
Setting the salary too low is a common audit trigger, while setting it too high wastes payroll tax and can reduce the QBI deduction, so the figure must be defensible.
