Reasonable Compensation (S-Corp)
What is reasonable compensation for an S corp?
The IRS says an S corporation must pay reasonable compensation to a shareholder-employee for the services that person provides to the corporation before non-wage distributions may be made. The IRS has the authority to reclassify payments to shareholders from distributions, which are not subject to employment taxes, to wages, which are. The IRS describes the key as determining what the shareholder-employee actually did for the corporation.
Numetix is the expert-led, AI-powered, human-in-the-loop bookkeeping layer that keeps owner pay and distributions reconciled to payroll, so your tax professional starts from clean numbers.
How to keep the records clear
- Run owner wages through payroll processing like any other employee
- Record distributions in a separate equity account, see owner draw
- Reconcile the related payroll liability accounts every month
- Document how the owner's role and pay were decided, and review it each year
For the entity choice behind these rules, see pass-through entity and our guide to S corp election deadlines.
Frequently asked questions
Can an S corp owner take only distributions?
The IRS says reasonable compensation must be paid to a shareholder-employee for services before non-wage distributions are made, and it can reclassify distributions as wages when pay is too low. How much counts as reasonable depends on the facts, so ask a tax professional to assess your situation.
How should wages and distributions be recorded?
Record wages through payroll, with the related payroll liabilities, and record distributions in a separate equity account. Keeping them separate lets your tax professional see how much was paid as wages and how much as distributions during the year.
Official source: IRS: S corporation compensation and medical insurance issues.
This page is for informational purposes only and does not constitute formal legal or tax advice. Always consult a qualified tax professional about your specific situation.
Related terms and guides: owner draw, payroll processing, payroll liability, and our tax services.