The Business Owner’s Guide to Reasonable Compensation
If you own a business taxed as an S corporation, how you pay yourself matters.
You can take money two ways:
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W-2 Payroll (reasonable compensation)
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Owner Distributions (profit)
The IRS expects both.
Your salary must be reasonable based on the work you do.
Not too high.
Not too low.
Justifiable.
Let’s walk through what that means.
What “Reasonable Compensation” Means
The IRS wants your salary to reflect what you’d pay someone else to do your job.
Think about:
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Your job duties
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Your hours
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Your skill level
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What similar roles earn in your industry and region
If your pay is too low, the IRS says you’re avoiding payroll taxes.
If it’s too high, you’re overpaying taxes you don’t need to.
This is why most business owners need to run payroll for themselves, not just “take draws.”
For a simple walkthrough of paying yourself the right way, review:
How to Pay Yourself from Your Business
Why It Matters
Reasonable compensation impacts:
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Payroll taxes
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Self-employment taxes
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Retirement contributions
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Audit risk
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Loan and financing applications
The right salary:
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Keeps you compliant
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Preserves tax efficiency
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Builds long-term financial stability
The wrong salary:
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Draws IRS attention
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Can trigger back taxes, penalties, and interest
How to Determine a Reasonable Salary
Use real numbers — not guesses.
Ways to support your salary amount:
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Local job boards
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Industry salary databases
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Compensation surveys
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Comparable job listings
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CPA guidance documenting rationale
Most business owners underestimate their value.
But many also underpay themselves to avoid taxes.
Avoid both extremes.
Where This Fits Into Your Larger Tax Strategy
Once your salary is correct, the rest of your profits can be taken as owner distributions, which usually avoid payroll taxes.
That’s where business owners create tax efficiency.
But your salary is the foundation.
It has to be defendable.
And once that foundation is set, additional planning becomes easier — like:
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Business deductions
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Retirement plan contributions
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Real estate planning
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Liability protection
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Multi-entity structuring
Some common planning areas that relate:
Home office + vehicle deductions:
Heavy Vehicle + Home Office Deductions
Rental real estate + business passthrough income:
Real Estate Professional Status & Passive Loss Rules
How the IRS classifies your real estate activities:
Real Estate Dealer vs. Investor Tax Differences
Entity transparency reporting requirements:
Corporate Transparency Act BOI Filing Requirements
These all work together to support:
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Compliance
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Tax savings
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Audit protection
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Long-term wealth building
When to Adjust Your Salary
Review your compensation any time:
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Revenue changes significantly
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Your role shifts
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You add employees
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You expand services
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You begin taking larger distributions
Your salary should evolve as your business grows — not stay static.
Common Mistakes to Avoid
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Paying yourself zero
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Only taking distributions
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Setting one number and never reviewing it
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Using “what feels right” instead of data
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Copying another business owner’s salary
Your business is unique.
Your compensation should be too.
FAQ
1. Do all S corp owners need to pay themselves a salary?
Yes. If you do meaningful work in the business, compensation is required.
2. How often should payroll run?
Monthly or biweekly is typical. Consistency matters.
3. Can I change my salary mid-year?
Yes. Adjust based on revenue and workload changes.
4. What if my business is brand new and not making much yet?
You can start low, but still document how you arrived at the number.
5. What happens if the IRS audits compensation?
They will ask for how the salary was determined. Having documentation puts you in a strong position.
At Provident CPAs, we specialize in helping clients adapt to changing economic conditions. Whether you’re a business owner or an individual looking to optimize your tax strategy, our team is here to guide you through the complexities of today’s tax landscape. Contact us today to learn more about how we can help you achieve financial independence, even in the face of economic uncertainty.