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Understanding Reasonable Compensation for S Corporation Owners
First of all, congratulations on taking that big step on your entrepreneurial journey by incorporating your business!
One of the key steps you’ll need to take is giving yourself a salary by putting yourself on payroll. If you’ve incorporated and elected to be taxed as an S corporation, you must pay yourself a "reasonable compensation" before taking non-wage distributions.
What Is Reasonable Compensation?
According to the IRS, "S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly...Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation."
Why Does Reasonable Compensation Matter?
Simply put, if you don’t pay yourself a reasonable salary, the IRS may reclassify distributions as wages and assess back taxes, penalties, and interest. Ensuring you follow this requirement helps you stay compliant and avoid unnecessary financial trouble.
How to Determine Your Reasonable Compensation
If you're unsure what amount qualifies as reasonable compensation, using a reasonable compensation calculator can help. One great tool is reasonablecompcalc.com, which provides an easy way to determine your reasonable compensation.
What If I Haven’t Paid Myself a Salary This Year?
Don’t panic—it’s not too late to correct this. Here’s what you need to do:
- Find a reputable payroll company – If you don’t have experience processing payroll, it’s best to use a professional service. A great option is ADP.
- Use a reasonable compensation calculator – Determine the reasonable compensation for your role.
- Inform your payroll provider – Let them know the salary amount so they can set up payroll properly.
Final Thoughts
Paying yourself a reasonable compensation as an S corp owner is not optional—it’s a legal requirement. By following the right steps, you can remain compliant while optimizing your tax benefits.
As the saying goes, “A journey of a thousand miles begins with a single step.” Ensuring your payroll is set up correctly is just one step in your entrepreneurial journey, but it’s a crucial one.
Wishing you success as you build your business!
