What is Reasonable compensation for an S Corporation?

Reasonable compensation is the IRS-required salary that S Corporation shareholder-employees must pay themselves for services performed. The amount must reflect what a comparable business would pay an unrelated employee for similar work, considering factors like experience, duties, time commitment, and geographic location. Setting reasonable compensation correctly is critical because salary is subject to FICA taxes, while S Corporation distributions above salary are not subject to employment taxes. The IRS audits S Corp returns where salaries appear artificially low relative to distributions and total business income.

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