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Tax strategy · Reasonable compensation
S corporation distributions are not subject to Social Security and Medicare tax, which tempts owners to take little or no salary. The IRS reclassifies distributions as wages when owner pay is not reasonable for the work performed. We set and document a defensible salary.
Serving United States, Virginia, Washington, DC, Maryland.
What we handle
An owner who performs more than minor services for an S corporation is an employee and must receive reasonable compensation before taking distributions. Since Rev. Rul. 74-44, the IRS has treated distributions paid in place of salary as wages subject to employment taxes, penalties and interest. Courts look at training and experience, duties and time spent, what comparable businesses pay for similar services, the company's revenue and the owner's role in generating it.
Reasonable pay also affects other planning. Wages reduce the section 199A qualified business income deduction but count toward its wage limit, retirement contributions are based on W-2 pay, and state unemployment and payroll taxes apply. A documented compensation study protects the position far better than a round number chosen at year end.
Speak with an advisorWhere we help
A CPA paid himself $24,000 a year and took large distributions. The court agreed that about $91,000 was reasonable compensation and upheld the employment tax assessment.
A real estate broker's distributions were partly wages; the court set reasonable pay at $40 an hour, or $83,200, and applied penalties.
The owner was an employee and amounts he took were wages, not loan repayments; employment taxes and penalties were sustained.
A lawyer who took no salary and only dividends owed employment taxes on them.
Our approach
Roles, hours, revenue and comparable pay data.
Salary, timing and payroll structure.
A compensation memo kept in the corporate records.
Representation if the IRS questions pay.
Questions
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No. There is no rule such as 60/40. Reasonable compensation is based on the services performed and what the market pays for them.
If the company truly has little cash, low pay may be reasonable, but taking distributions while paying no salary is the pattern courts reject.
Yes. Owner wages are not qualified business income, so higher pay lowers the deduction, but wages can help meet the deduction's W-2 wage limit.
The company owes employer and employee Social Security and Medicare tax, federal unemployment tax, interest and often penalties.
A written analysis using salary surveys or comparable job data for each role you perform, updated as the business changes.
Often yes, because revenue comes from the owner's personal services, which supports higher compensation.
Latest updates
Authorized representatives can now make balance-due, amended return, extension, proposed assessment and federal tax deposit payments for business clients online. Appropriate authorization for the client and tax matter is required.
Source: IRS (IR-2026-134)
For 2027 the joint-return standard deduction rises to $33,200, the estate tax basic exclusion to $15,480,000, the annual gift exclusion to $20,000 and the Section 179 expensing limit to $2,640,000. Our advisors recommend revisiting year-end gifting and equipment purchase plans with these figures in mind.
Source: IRS (IR-2026-133)
All 6,576 nominated census tracts, including 2,594 rural tracts eligible for enhanced benefits, become Opportunity Zones on January 1, 2027 for ten years. Investors with capital gains should review the new map before committing funds.
Source: IRS (IR-2026-132)
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