Question: Jeff is the 100% owner/shareholder of an S corporation that provides psychiatric services to hospital patients, both on-site and through telehealth. He does his own bookkeeping and office management. No one else works for him. How is reasonable compensation determined for Jeff?

Answer: Jeff must pay himself a reasonable wage before taking any distributions from the S corporation. The IRS requires that shareholder-employees be paid a salary commensurate with the services they provide. Jeff wears two hats: he’s a practicing psychiatrist and his office administrator.

To calculate reasonable compensation, he should use benchmark data such as the Bureau of Labor Statistics or medical industry surveys to determine average pay rates for each role. He then must estimate how much time he devotes to clinical work versus administrative tasks and multiply those hours by appropriate rates.

If he works 40 hours a week, spending 30 on psychiatric care at $130/hour and 10 on administrative duties at $25/hour, a defensible annual compensation level would be around $215,800 [($130 x 30) + ($25 x 10) x 52]. Failing to do so could lead to IRS scrutiny, wage reclassification and unexpected payroll tax assessments.