Lesson 6 of 11
Reasonable compensation
A shareholder who works in the business must be paid a reasonable wage for that work before taking distributions.
How reasonableness is judged
- Duties performed and time devoted to the business
- Training, experience and responsibility
- What comparable businesses pay for similar roles
- The company's revenue, profitability and dividend history
- Payments to non-owner employees doing similar work
Getting it wrong
If the salary is unreasonably low, the IRS can reclassify distributions as wages, with back employment taxes, interest and penalties. A zero-salary S corporation with an active owner is a well-known audit target.
Document how you arrived at the figure: role description, hours, and comparable market data. Contemporaneous evidence is worth far more than a later explanation.
Not sure whether the election fits?
The numbers depend on your profit, your role in the business and your state. Gullia Filing's tax team reviews your position, prepares Form 2553 where it makes sense, and sets up payroll so the election holds up.