# Reasonable compensation

> The factors that set an S corporation owner's salary, and the payroll and distribution entries that follow.

Source: https://lopifi.com/learn/s-corporation-election/reasonable-compensation
Part of: Lopifi — US GAAP books on autopilot, checked by a CPA (https://lopifi.com)

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**What is reasonable compensation for an S corp owner?** The factors that set an S corporation owner's salary, and the payroll and distribution entries that follow.

The IRS doesn't publish a number. It lists the factors that set what is reasonable for the work: training and experience, duties and responsibilities, time and effort devoted to the business, dividend history, payments to non-shareholder employees, the timing and manner of bonuses to key people, what comparable businesses pay for similar services, compensation agreements, and the use of a formula. Too low a salary is the classic S corporation audit issue.

> “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.”

— [IRS, S corporation compensation and medical insurance issues](https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues), Reasonable compensation, and the factors that set it

The consultant's year in the books: the salary runs through payroll with FICA withheld and matched, and the remaining profit goes out as a distribution, which is equity, not an expense — the S corporation's counterpart of an owner's draw or a dividend. These are summary entries for the year, before income tax withholding.

*[Figure: payroll withholding]*

The salary is a paycheck like any other: withholding, FICA, deposits. Illustrative figures.

**Wrong:** No salary; $150,000 taken as distributions.

**Right:** $90,000 salary through payroll, $53,115 distributed.

Paying no salary and taking everything as distributions is exactly what the rule forbids. The IRS can reclassify distributions to an officer as wages, to the extent they are reasonable compensation for the work, and collect the employment taxes on them.

> “The IRS has the authority to reclassify payments made to shareholders from non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes).”

— [IRS, S corporation compensation and medical insurance issues — reclassification](https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues), Distributions in place of a salary can be reclassified as wages

## Where this page's rules come from

- [IRS, S corporation compensation and medical insurance issues](https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues) — Reasonable compensation, and the factors that set it (irs)
- [IRS, S corporation compensation and medical insurance issues — reclassification](https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues) — Distributions in place of a salary can be reclassified as wages (irs)
- [IRS Pub. 15 (2026), What's New](https://www.irs.gov/pub/irs-pdf/p15.pdf) (PDF) — Social Security and Medicare tax for 2026 (irs)

## Read further

- https://lopifi.com/md/startups/payroll-journal-entries

- **Track:** [Entity types](https://lopifi.com/md/learn/entities)
- **Part of:** [The S corporation election](https://lopifi.com/md/learn/s-corporation-election) — 4 min
- **Terms taught:** [Reasonable compensation](https://lopifi.com/md/glossary/reasonable-compensation), [FICA](https://lopifi.com/md/glossary/fica), [Payroll liabilities](https://lopifi.com/md/glossary/payroll-liabilities)
- **Previous:** [The S corporation election](https://lopifi.com/md/learn/s-corporation-election)
- **Next:** [Why startups are Delaware C corporations, Entities · Lesson 4](https://lopifi.com/md/learn/why-startups-are-delaware-c-corps)
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