The S-Corp Owner’s Guide to Reasonable Compensation

Table of Contents

1. Introduction
   
   
2. What Is Reasonable Compensation?
   
   
3. Why It Matters for Fitness Business Owners
   
   
4. How to Determine the Right Salary
   
   
5. Real-World Scenarios
   
   
6. IRS Red Flags and Penalties
   
   
7. What to Document (and Why)
   
   
8. How Ledge Helps
   
   
9. Final Thoughts + Video Insights from Bruce
   
   

1. Introduction

If you’ve elected S-Corp status for your fitness business, understanding reasonable compensation isn’t just a technicality — it’s a required step for staying compliant with IRS rules. S-Corp owners who actively work in their businesses must pay themselves a fair salary for their role. Skip this, and you could face serious consequences, including audits, back taxes, and penalties.

This guide explains what counts as reasonable, how to calculate it, and how Ledge helps fitness business owners stay on track.

2. What Is Reasonable Compensation?

Reasonable compensation is the salary an S-Corp owner must pay themselves before taking any distributions. This salary must reflect the fair market value of the work you perform — whether that’s coaching classes, managing staff, or running day-to-day operations.

"The key is paying yourself a salary that reflects the value of the services you perform." – IRS Guidance, Topic No. 761

The goal is to ensure you’re contributing to payroll taxes (Social Security and Medicare) on your wage, while still enjoying the tax advantages of S-Corp distributions.

3. Why It Matters for Fitness Business Owners

In the fitness industry, many S-Corp owners wear multiple hats. You may be coaching clients, handling sales, running operations, or all three. If you’re actively working in your business, the IRS expects you to pay yourself a wage in line with those duties.

Taking only distributions (which are not subject to payroll taxes) is a major audit trigger. The IRS has become more aggressive in flagging this behavior.

Bruce Newman: “We often see studio owners who don't realize that taking all income as distributions puts them at risk. Paying a reasonable salary is a non-negotiable part of S-Corp compliance.”

4. How to Determine the Right Salary

Step 1: Break Down Your Role

List out all your job functions — are you teaching classes? Handling payroll? Running marketing?

Step 2: Use Salary Benchmarks

Use tools like RCReports or check local job boards to find going rates for similar roles in your area.

Step 3: Adjust for Time Spent

If you’re part-time in the business, reduce the rate accordingly. If you perform multiple roles, calculate a blended average.

Step 4: Document Your Logic

Save all your sources and notes. If the IRS ever audits you, having this documentation in place could protect you from reclassification.

5. Real-World Scenarios

Example 1:
A gym owner earns $180,000 in net income but takes no salary.
Result: The IRS deems that $80,000 should have been wages. They owe back payroll taxes, penalties, and interest.
IRS can, at their discretion, recharacterize distributions to wages.

Example 2:
A yoga studio owner teaches 20 hours/week and handles admin work. Salary benchmarks show $30/hour for instruction and $45/hour for admin. A blended wage would land around $50,000–$55,000/year.

“Owners often undervalue the admin and leadership work they do — not just the coaching. That’s where underpayment risks begin.”  — Bruce Newman

6. IRS Red Flags and Penalties

If you’re not paying yourself a reasonable salary, the IRS may:

• Reclassify your distributions as wages
  
  
• Assess back payroll taxes and interest
  
  
• Impose penalties (up to 100% of unpaid employment taxes)
  
  
• Flag you for future audits

Case reference: In Watson v. U.S., a CPA paid himself an unreasonably low salary. The court sided with the IRS and enforced over $20K in back taxes.

7. What to Document (and Why)

• Time logs or calendar showing weekly hours worked
  
  
• Job roles performed and responsibilities
  
  
• Salary comparison data for similar roles
  
  
• Notes explaining how your final wage was calculated
  
  

This documentation proves good-faith effort and protects you if the IRS ever challenges your payroll setup.

8. How Ledge Helps

Ledge delivers monthly financials by the 7th, with accurate wage tracking and manual reconciliation. We break down:

• Wages vs. distributions clearly on your P&L
  
  
• Departmental pay (instructors vs. admin)
  
  
• Real insights for how to structure S-Corp compliance long-term
  
  

"It’s not about avoiding taxes — it’s about structuring your business to stand up to IRS standards. That’s what we help fitness business owners do every day." — Bruce Newman

‍Ready to review your current S-Corp setup?

Book a Financial Discussion with Ledge Accounting today.

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