Tax
Reasonable compensation
Reasonable compensation is the salary an S-Corporation must pay a shareholder who works in the business, before profit can be distributed without employment tax. The IRS expects the amount to reflect what the role would command at arm's length, considering duties, experience and industry.
In plain terms: A believable salary for the work you actually do, which the IRS expects you to pay yourself first.
Why it matters
The constraint that makes or breaks an S-Corp election. Paying an implausibly small salary to maximise distributions is a well-known audit trigger, and reclassification brings back taxes, penalties and interest.
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