Updated on December 19, 2025 by David Korpel

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If you own an S-Corporation, there’s one number on your tax return that quietly carries more risk than almost any other:

Your reasonable compensation.

It’s easy to underestimate because it sounds simple. It’s not.
And it’s easy to delay because nothing breaks immediately. Until it does.

Reasonable compensation is one of the most audited, challenged, and reclassified areas of S-Corp taxation. And while most owners focus on choosing a “reasonable” salary, the real issue the IRS cares about is this:

👉 Can you prove how you got there?

That’s where most problems start — and where most S-Corp owners are exposed heading into a new tax year.

What Is Reasonable Compensation (Plain English Version)

If you own an S-Corp and work in the business, the IRS expects you to:

1. Pay yourself a salary (subject to payroll taxes), and
2. Take additional profits as distributions (not subject to payroll taxes).

Reasonable compensation is the salary portion of that split.

The IRS definition, simplified:

What would you have to pay someone else to do your job, with your responsibilities, in your location, given your experience?

Not:

• What minimizes taxes the most
• What your friend pays themselves
• What feels “safe”
• What you’ve always done

It’s a fact-based determination, not a guess.

Why the IRS Cares (A Lot)

The IRS focuses on reasonable compensation for one reason: payroll taxes.

When S-Corp owners underpay wages and overpay distributions, the government loses:

• Social Security tax
• Medicare tax
• FUTA
• State and local payroll taxes

That’s why reasonable compensation is:

• A top S-Corp audit trigger
• A recurring issue in Tax Court cases
• Often examined first when an S-Corp is reviewed

And no — “my accountant said it was fine” doesn’t hold up in an audit.

There Is No Safe Percentage (This Is Important)

One of the biggest myths is using a fixed percentage of profits:

“I just pay myself 40% — that’s reasonable, right?”

Unfortunately:

• The IRS doesn’t accept fixed percentages
• Courts don’t support them
• Two businesses with identical profits can justify very different salaries

Reasonable compensation depends on:

• Your role and responsibilities
• Time spent in the business
• Industry norms
• Experience, education, and credentials
• Geographic labor markets
• Whether systems or employees do most of the work

That’s why documentation matters more than the number itself.

What the IRS Actually Looks For

When the IRS evaluates reasonable compensation, they examine both logic and evidence.

They look at:

• What the business does
• What you actually do
• How involved you are day-to-day
• Comparable roles and wages
• Whether profits are driven by your labor

They also expect supporting documentation, such as:

• Job descriptions
• Corporate minutes
• Employment agreements
• Time involvement
• Third-party wage data
• Consistency across years

If you can’t clearly explain why your salary is what it is — that’s when trouble starts.

The Most Common Mistake S-Corp Owners Make

It’s not choosing the “wrong” number.

It’s having no documented process behind the number.

Many owners assume:

• If the salary feels reasonable, it’s fine
• If no one questions it, it’s safe
• If they fix it later, that’s good enough

The reality is this:
👉 The IRS judges your decision based on what you knew and documented at the time — not what you fix after the fact.

Why Timing Matters (Especially Before Year-End)

Reasonable compensation isn’t something you want to:

• Rush in March
• Guess at during tax prep
• Adjust retroactively without support

The best time to evaluate and document reasonable compensation is:

• Before the year ends, or
• As early as possible in the new year, before payroll patterns are set

That way:

• Your salary is aligned before W-2s are issued
• Adjustments can be made cleanly
• Documentation reflects proactive decision-making, not damage control

Waiting until after the fact limits your options.

How Salary Sherpa Solves This Problem

Salary Sherpa is a reasonable compensation reporting tool built specifically to turn reasonable compensation into a defensible, documented tax position — not a guess.

Each Salary Sherpa report:

• Walks you through your actual role in the business
• Uses third-party wage data to support conclusions
• Clearly explains how your salary was determined
• Identifies supporting documents the IRS expects to see
• Produces a clean, audit-ready report you can rely on year after year

This isn’t theoretical guidance. It’s built for real S-Corp owners making real payroll decisions.

Want to See What the Report Looks Like?

You don’t have to guess.

You can view a sample Salary Sherpa report to see:

• The structure
• The level of detail
• The type of analysis provided
• How conclusions are supported

(Yes — even Avon Barksdale needed reasonable compensation.)

Seeing the sample makes it immediately clear whether this is something you want in your tax file.

Final Thought

Reasonable compensation isn’t about finding the lowest number that won’t get flagged.

It’s about being able to say:

“This is how we determined it — and here’s the support.”

If you’re an S-Corp owner heading into a new year without documented reasoning behind your salary, that’s not a failure — it’s an opportunity to fix it before it becomes a problem.

And the earlier you do it, the stronger your position is.

Note: Salary Sherpa isn’t an ENGAGE product — it’s something I built independently to solve a very real gap I kept seeing with S-Corp clients.

About The Author

David Korpel

After graduating from college, David jumped right into public accounting, where he first met Mike. This experience established a well-rounded technical foundation. He gained a wealth of experience traveling the country performing audits, reviews, compilations, and tax engagements before joining up with Mike again as ENGAGE’s first employee.

As Chief Operating Officer, Dave is in charge of keeping our client relationships as fun, informative, educational, and productive as possible. He aims to be supportive, informative, proactive, and trustworthy. Whether wearing his bookkeeping, tax, forensic accounting, or social media hat, his focus consistently remains on adding value for our clients. He is inspired by the innovation and entrepreneurial spirit of clients. His passion for helping small business owners make sense of their numbers and remove any stress and anxiety related to their financials and taxes is second only to the love for his family.

Dave’s wife, Laura, son Lincoln, and daughter Luna are his motivation every day to grow, learn, and love what he does. They live in Skippack, PA and can often be found hiking on another new trail in the area or walking into town for a bite to eat. And boy, are they a hungry bunch!