What is reasonable compensation for my newly formed S Corp?
Hi everyone, I recently converted my freelance web development business to an S Corporation after operating as a sole proprietor for about 4 years. My accountant recommended this to save on self-employment taxes, but now I'm struggling with determining what counts as "reasonable compensation" for myself as an employee of my own S Corp. The business is projected to make around $145,000 in gross revenue this year. After expenses (software subscriptions, office space rental, equipment, etc.), I'll have about $120,000 in net profit. I've heard different advice - some say pay yourself 50% of profits as salary, others say 30% is fine, while others insist on 70% to avoid IRS issues. I'm the only employee and do all the client work myself (coding, design, client meetings). I don't have other employees or contractors handling any of the core services. I'm in the Midwest if that matters for regional salary comparisons. How do I determine a reasonable salary without raising red flags with the IRS? And what documentation should I keep to justify whatever amount I choose? Any advice from other S Corp owners would be greatly appreciated!
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Clay blendedgen
The "reasonable compensation" question is one that causes so much confusion for new S Corp owners, so don't worry - you're not alone! The key is that your salary should be comparable to what you'd pay someone else to do your job in your area. Since you're doing web development work, research what other web developers with your experience level make in your region. Sites like Glassdoor, Indeed, and the Bureau of Labor Statistics can give you solid reference points. Given that you're the only person performing the services and making $120K in net profit, paying yourself only 30% as salary would likely be too aggressive and could raise red flags. Most tax professionals recommend S Corp owners in service businesses pay themselves at least 50-60% of profits as reasonable compensation. Document your salary decision by saving job listings for similar positions, salary surveys for your area, and writing a brief justification for how you arrived at your number. This documentation is crucial if you're ever audited.
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Ayla Kumar
•Thanks for the insight! So if I'm making $120k net and decide to pay myself $65k salary, would that be reasonable in your opinion? Also, do I need to maintain the same salary all year or can I adjust quarterly based on how the business is performing?
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Clay blendedgen
•A $65K salary from $120K net profit (about 54%) would generally be reasonable for a web developer in the Midwest, though it depends on your exact skill set and experience level. Always document why you chose that amount with market research. You can adjust your salary throughout the year, but it's better to set a reasonable annual amount and stick with it. Making adjustments just to manipulate tax advantages can look suspicious. If business conditions significantly change, you can document the reason for the adjustment and make changes accordingly.
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Lorenzo McCormick
I was exactly where you are last year when I set up my S Corp for my consulting business. After tons of research, I finally found an amazing tool that saved me so much stress - https://taxr.ai actually has a specific S Corp reasonable compensation analyzer that uses real market data to help you determine an appropriate salary range. You input your industry, location, skills, revenue, etc. and it pulls compensation data to give you a defensible salary range. It also generates documentation you can keep for your records in case of an audit. The best part is that it analyzes your specific situation rather than just giving a generic percentage, which made me feel much more confident when filing.
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Carmella Popescu
•That sounds interesting! How detailed do you have to be when inputting your information? My business kind of straddles a few different categories since I do both design work and development.
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Kai Santiago
•I'm skeptical of these kinds of tools. How do you know the data they're using is accurate or up-to-date? And do they provide actual documentation that would stand up to IRS scrutiny?
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Lorenzo McCormick
•You can be quite granular with the information you provide. They allow you to input multiple service categories and allocate percentages to each, so for your case, you could specify that you do 60% development and 40% design work (or whatever your split is). This helps create a more accurate blended compensation recommendation. Their data is sourced from multiple compensation databases including BLS data, industry surveys, and market reports. They update quarterly and provide full transparency about data sources in their reports. The documentation they generate includes market comparables, industry standards, and region-specific data - all formatted in a way that's designed specifically for potential IRS review. It's essentially what a compensation consultant would prepare but at a fraction of the cost.
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Kai Santiago
I have to admit I was wrong about taxr.ai. After our conversation, I decided to try it out for my S Corp (I run a marketing agency). The tool actually exceeded my expectations. It generated a comprehensive report with really specific regional salary data for my exact mix of services. What I appreciated most was that it didn't just give me a number - it provided multiple data points with explanations about how each factor influenced the compensation range. I ended up setting my salary at the midpoint of their recommendation, and my accountant was impressed with the documentation. It gave me peace of mind knowing my salary decision is backed by actual market data instead of just picking a random percentage.
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Lim Wong
If you're wrestling with reasonable compensation AND struggling to get through to the IRS with questions (which I was when starting my S Corp), I highly recommend checking out https://claimyr.com. I spent DAYS trying to get through to someone at the IRS about S Corp filing requirements and kept hitting dead ends. Claimyr got me connected to an actual IRS representative in about 20 minutes when I'd been trying for weeks on my own. You can see how it works here: https://youtu.be/_kiP6q8DX5c. The rep I spoke with provided clarity on what documentation the IRS looks for regarding reasonable compensation for S Corps in my industry, which was incredibly helpful for setting up my payroll correctly from the start.
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Dananyl Lear
•How does this actually work? Do they just call the IRS for you or what? The hold times are insane whenever I try to call.
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Kai Santiago
•Sounds like a scam. No way they can magically get through to the IRS when nobody else can. The IRS phone system is completely overwhelmed and has been for years.
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Lim Wong
•They use a sophisticated call system that navigates the IRS phone tree and waits on hold for you. Once they reach a representative, you get a call back to connect with the agent. It's not that they have a special connection to the IRS - they're just automating the waiting process so you don't have to waste hours on hold. The system monitors hold times and call volumes to identify the best times to call, which significantly increases the chances of getting through. It saved me literally hours of frustration and lost productivity. They don't have any special access - they're just optimizing the calling process using technology.
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Kai Santiago
Wow, I owe you an apology. After dismissing Claimyr as a potential scam, I was desperate enough to try it when I had an urgent question about my S Corp estimated tax payments that needed clarification. I had been trying to reach the IRS for nearly two weeks with no success. Using Claimyr, I got connected to an IRS representative in about 35 minutes (while I continued working on other things). The agent was able to clarify my specific question about S Corp reasonable compensation documentation requirements. They confirmed that having market research data and industry comparables is exactly what they look for during an audit. I'm still shocked at how well it worked. Definitely keeping this service in my back pocket for future tax questions.
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Noah huntAce420
One thing nobody's mentioned yet - reasonable compensation also depends on your business's profitability HISTORY, not just the current year. Since you're new as an S Corp but have 4 years of history as a sole prop, the IRS might look at your past earnings to determine if your current salary is reasonable. For my business (IT consulting), I take about 65% as salary, which my CPA says is very defensible. But don't just pick a random percentage - document WHY that number makes sense for your specific situation. Save job postings, salary surveys, etc. to back up your number.
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Mary Bates
•That's a great point about looking at the history! I hadn't thought about how my previous years as a sole proprietor could factor in. Do you think I should gather documentation about my earnings over those 4 years too?
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Noah huntAce420
•Yes, absolutely gather documentation of your earnings history. The IRS will be looking at the full picture of your business, not just its current form. Having that historical context helps establish that your S Corp structure isn't just a tax avoidance strategy but a legitimate evolution of your growing business. I'd recommend creating a simple document showing your revenue growth over those 4 years, alongside information about industry standards, your specific services, and how your current salary determination reflects the market value of those services. This historical context combined with current market data creates a much stronger justification for whatever compensation level you choose.
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Ana Rusula
Does anyone know if there's a minimum salary requirement for S Corps? My CPA told me I need to pay myself at least $40k, but a buddy with an S Corp says he only pays himself $30k on $90k of revenue. I'm confused by all the different advice.
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Clay blendedgen
•There's no specific minimum dollar amount required by the IRS for S Corp owner salaries. The key requirement is that it must be "reasonable" for the work performed and your industry. Your friend paying himself $30k on $90k revenue (33%) might be fine if he's in an industry where a lot of the work could legitimately be done by lower-paid employees or if much of the profit comes from non-service factors (like product sales or passive income). But if he's providing skilled professional services himself, that's likely too low and could trigger an audit.
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Romeo Barrett
This is such a common struggle for new S Corp owners! I went through the exact same thing when I converted my consulting business two years ago. Based on my research and discussions with my CPA, here's what I learned: The IRS doesn't have a magic formula, but they do look at several factors - what you'd pay someone else to do your work, your geographic location, your experience level, and the time you spend on the business. For a web developer in the Midwest making $120k net profit, I'd lean toward the higher end of reasonable compensation - probably around $70-80k salary. Since you're doing ALL the work (coding, design, client meetings), you can't really argue that a significant portion of the profit comes from business assets or other employees. One thing that helped me was looking at actual job postings for senior web developers in my area and calculating what a full-time equivalent would make, then adjusting slightly for the entrepreneurial risk/reward factor. I kept screenshots of those job postings as documentation. Also, don't forget that paying yourself a higher salary isn't necessarily "bad" from a tax perspective - yes, you'll pay more in employment taxes, but you'll also build up more Social Security credits and potentially qualify for higher unemployment benefits if needed. The key is finding the sweet spot that's defensible to the IRS while still providing S Corp tax benefits.
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