What is Reasonable Compensation?

Part of the requirements of an S corporation is that shareholder-employees be paid a reasonable salary or reasonable compensation. The net profit or loss flows through to the taxpayer in an S corporation. Still, it is qualified as a distribution instead of as self-employment income, therefore avoiding self-employment taxes. To ensure some taxes are paid, shareholder-employees are required to pay themselves “reasonable compensation” — that is, an amount similar to the market rate for the duties they fulfill for the company.