Describe the owner’s actual services
List delivery work, management, sales, administration, supervision, hours, and responsibility for key outcomes. Identify which tasks generate revenue and which are performed by other staff. Preserve the role description and explain changes during the year. The IRS states that S corporations must pay reasonable compensation to shareholder-employees for services before making non-wage distributions to them. There is no universal salary percentage that resolves every situation.
Build a supportable review with an adviser
Discuss relevant compensation data, business conditions, the owner’s experience, work performed, and available cash. Record the sources and judgment used rather than selecting a round number solely to reach a desired tax result. Coordinate payroll and any owner benefit treatment with the preparer. Distinguish salary, expense reimbursements, distributions, and loans in the books so the records reflect what each payment actually represents.
Monitor changes during the year
Review the arrangement when duties, profitability, hours, or staffing change. Reconcile wage payments and payroll filings before year end so an issue can be addressed with time to act. Preserve minutes or other appropriate documentation of the decision where advised. For example, moving from part-time management to full-time client delivery is a factual change that should reach the compensation reviewer, even if distributions stayed the same.
- Document the services, hours, and responsibilities of each working owner.
- Use relevant evidence and professional judgment to review compensation.
- Keep wages, reimbursements, distributions, and loans distinct.
- Reassess compensation after meaningful role or business changes.
Questions to consider
Can I use a standard salary-to-distribution ratio?
A fixed ratio does not establish reasonable compensation for every owner. The facts and services performed need review and documentation.
What happens if payments are classified incorrectly?
The IRS can reclassify certain payments as wages. Ask a qualified adviser to assess the specific facts, correction options, and related payroll consequences.
Official sources and further reading
Use this guide to prepare questions and organize records. It does not determine eligibility, establish a professional engagement or guarantee a tax or business outcome.