Maryland S-Corp Owners: Why Reasonable Compensation Matters

Setting a “reasonable compensation” salary for S-corporation shareholder-employees is not optional—it’s required by the IRS. Getting it right protects your Maryland S-corp, optimizes taxes, and reduces audit risk.

Many business owners don't realize that if you're an S-corporation (filing Form 1120S or Maryland Form 510), the IRS requires that you pay yourself a reasonable salary.

Why reasonable compensation is critical

- IRS compliance: The IRS expects S-corp owners who work in the business to take a market-rate W‑2 wage for services performed. Underpaying invites IRS audits, which would likely result in reclassification of distributions as wages, back payroll taxes, penalties, and interest - potentially costing thousands of dollars.

- Tax efficiency: A balanced mix of salary and distributions can minimize FICA/payroll taxes while staying compliant. Too low a salary risks penalties; too high may increase unnecessary payroll tax.

- Maryland requirements: When proper payroll is setup, care is needed to ensure the S-corp is in compliance with Maryland withholding and unemployment insurance.

- Retirement and benefits: Your W‑2 wage drives retirement plan contributions (e.g., Solo 401(k), SEP-IRA) and can support better benefits planning.

- QBI considerations: For higher-income owners, paying reasonable W‑2 wages can help with Section 199A wage-limit mechanics while maintaining an efficient salary/distribution strategy.

How to determine a reasonable salary in Maryland

- Match the market: Use comparable wages for your role, industry, and region (Maryland/Montgomery County) for the tasks you actually perform.

- Factor your role and time: Duties, hours, experience, revenue responsibility, and profit margins matter.

- Use accepted methods: Market-rate comparison, time-and-task (cost) approach, or a blended model.

- Document everything: Keep written support—job duties, hours, comps, formulas, and annual review notes—and run payroll with proper withholdings and filings.

Conclusion and next step

Protect your S-corp, reduce audit risk, and optimize taxes with a defensible reasonable compensation plan. Contact Aventa Tax in Montgomery County, Maryland for a tailored reasonable compensation analysis and Maryland S-corp compliance support.

Call us at 301-235-2724 or read more here S-Corp Tax Preparation Services in Montgomery County, MD | Aventa

The information presented in this article is for educational purposes only. Please consult a tax professional for specific advice for your situation.