Summary of What This Blog Covers:
- What “reasonable compensation” means for S-Corp owners
- Why the right salary helps avoid audits and penalties
- How the IRS evaluates if your salary is compliant
- How Insogna builds smart, IRS-proof salary strategies
You’ve taken the leap.
You formed an S Corporation, filed that Form 2553, and you’re ready to cash in on those sweet, sweet tax advantages. You’re playing in the big leagues now. More strategy, more control, more profit.
But before you start thinking the IRS is just going to let you slide into lower tax rates and fat distributions without a catch, think again.
Because there’s one thing they are laser-focused on: your reasonable compensation.
At Insogna, your trusted Austin, Texas CPA and growth partner, we know this rule better than anyone. And trust us, it’s not just a compliance box. It’s your frontline defense against audits, penalties, and financial drama you absolutely don’t need.
Let’s break it all the way down.
First: What Does “Reasonable Compensation” Actually Mean?
Reasonable compensation is exactly what it sounds like. If you weren’t doing the work inside your S-Corp, what would you have to pay someone else to do it?
It’s not about what’s leftover after expenses. It’s not what feels right based on how much you want to keep. It’s about market value for the work you perform, plain and simple.
You’re not just an owner now, you’re also an employee.
Which means you must:
- Pay yourself a legitimate salary via payroll (yes, with income tax and payroll tax withholdings)
- Issue yourself a W-2 at year-end
- Track and document why that number is reasonable in your industry and region
No salary? Too little salary? Big red flags.
The IRS expects S-Corp owners to respect the line between salary (wages) and distributions (profit). Mess that up, and you’re asking for trouble.
Why Reasonable Compensation Is Such a Big Deal
Let’s put it bluntly: The entire reason you set up an S-Corp was to save money on self-employment taxes, right? If not, your tax preparer near you needs a serious talking-to.
The strategy works because distributions aren’t subject to Social Security and Medicare taxes. But guess what? If you don’t pay yourself a fair salary first, the IRS sees it as cheating.
Here’s what’s at risk if you get it wrong:
- IRS reclassifying your distributions as wages
- Retroactive payroll taxes assessed (ouch)
- Massive penalties and interest
- Potential audit of multiple years’ tax returns
- Increased scrutiny on future filings
And don’t think the IRS is too busy to notice. They’ve been cracking down harder every year especially since S-Corp setups have exploded among small businesses and freelancers.
At Insogna, we know exactly what the IRS looks for because we stay ahead of the trends. We build defenses into your reasonable salary strategy from day one so you never have to sweat an audit.
How Does the IRS Decide What’s Reasonable?
Spoiler: There’s no single magic number. No one-size-fits-all chart.
(If there were, we’d print it, laminate it, and hand it to every client.)
Instead, the IRS looks at several key factors:
- The type of work you do
- Your training, education, and experience
- How much time you spend working for the business
- What similar businesses pay for similar roles in your area
- Your company’s size, profitability, and cash flow
- Geographic economic differences (what’s reasonable in Austin isn’t the same as NYC or rural Texas)
And if you think the IRS doesn’t check? They absolutely do. They use salary comparison tools, public job listings, market data—everything.
That’s why we at Insogna, a trusted Austin accounting service, use real-world salary databases to document and defend your salary. When we say “reasonable,” we mean IRS-proof reasonable.
Real-World Example: Two Paths, Two Very Different Outcomes
Let’s say you own a thriving online consulting business.
You pull in $300,000 in revenue annually.
You do everything: sales, service delivery, project management, billing. You’re the business.
Option 1: You pay yourself a $30,000 salary and take $270,000 in distributions.
Sounds like a great tax-saving move, right? Wrong.
To the IRS, this screams “avoiding payroll taxes.” Expect reclassification, back taxes, penalties, and an audit headache you’ll never forget.
Option 2: You pay yourself a $100,000 salary based on comparable market data for your role and industry.
You take the remaining profits as distributions.
Salary taxes are paid, and your audit risk? Practically zero.
One option builds wealth and security.
The other? It’s an expensive lesson you don’t want to learn the hard way.
At Insogna, we make sure you’re always living in Option 2 and reaping every legal tax advantage while doing it.
Big Mistakes S-Corp Owners Make (And How You’ll Avoid Them)
Mistake #1: Paying Yourself Nothing.
If your S-Corp has profits, you need to pay yourself a salary. Period. No salary means automatic audit bait.
Mistake #2: Picking a Random Salary Based on Gut Feelings.
We love gut instinct for business decisions. Not for tax strategy. Use real compensation data.
Mistake #3: Forgetting to Adjust Salary As You Grow.
As your business revenue climbs, so should your reasonable compensation. If you were worth $70,000 last year and now you’re managing a million-dollar operation, it’s time to update the numbers.
Mistake #4: Thinking “Small Business” Means “Small IRS Risk.”
Size doesn’t matter to the IRS. Poor payroll practices can trigger investigations at any revenue level.
Partnering with an expert small business CPA Austin like Insogna means these mistakes stay firmly in your rearview mirror.
But Wait There’s More: Why Salary Affects Your Future Too
Let’s get strategic for a second:
Your salary doesn’t just matter for today’s taxes. It affects your entire financial picture:
- Retirement contributions (401(k), SEP IRA, Solo 401(k) plans)
- Social Security eligibility down the line
- Loan qualifications for mortgages or business credit
- Health insurance reimbursements through your S-Corp
Set it too low, and you’re cutting yourself off from building future wealth. Set it strategically and documented properly, you’re setting yourself up to win long-term.
We love showing clients how smart salary planning fits into business tax, personal wealth goals, and future exit strategies. It’s bigger than a paycheck. It’s your legacy.
How Insogna Handles Reasonable Compensation Like a Pro
When you work with us, here’s what you’re getting (besides peace of mind):
- Custom-built salary benchmarking reports using IRS-accepted data sources
- A fully documented reasonable compensation analysis ready to present during any audit
- Year-over-year salary reviews and strategic tax planning
- Alignment of your salary with retirement contributions, profit-sharing, and benefit optimization
Whether you need help as an S-Corp, tax preparation services near you, or broader accounting services to support your whole operation, Insogna is your secret weapon.
No templates. No shortcuts. Only tailored, bulletproof strategies designed to keep you compliant and profitable.
FBAR Filing, Foreign Income, and Reasonable Salary
Got foreign bank accounts? Own overseas investments or operate globally?
Your salary also impacts FBAR filing and foreign income reporting. If you mismanage your compensation, you risk triggering scrutiny not just domestically but internationally.
Another reason why partnering with an experienced tax professional near you like Insogna matters. We see the whole playing field and we make sure you win at every level.
In Closing: Reasonable Compensation Is How You Play to Win
Here’s the bottom line: S-Corps are powerful tools for entrepreneurs. But only if you play the game correctly.
Reasonable compensation isn’t an annoying IRS rule. It’s your ticket to building a smarter, stronger, more audit-proof business.
It’s not a chore. It’s your advantage.
With Insogna by your side, you’ll turn tax season into an opportunity, not a liability.
Ready to get serious about your S-Corp strategy? Contact Insogna today. Let’s lock in your reasonable salary, safeguard your success, and make your business bulletproof.