What is S-Corp Election (Reasonable Compensation)?
Definition Electing S corporation status lets a profitable business split an owner's pay into a reasonable salary, which is subject to payroll taxes, and remaining distributions, which are not subject to self-employment tax. The IRS requires that the salary be reasonable for the work performed, so owners cannot pay themselves an artificially low wage. The savings must be weighed against added payroll and compliance costs.
It can meaningfully cut self-employment tax for the right business, but setting defensible reasonable compensation is essential to withstand IRS scrutiny.