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Hearth Agency
Reasonable Compensation Methodology

How a defensible S-Corp compensation position gets built

The IRS does not publish a salary table or percentage safe harbor for S-Corp owners. The question turns on the shareholder-employee's services, the facts of the business, comparable compensation, and the record supporting the position.

Start with the StandardSee the HearthRC Method
The standardSee the IRS rule and the factors that inform reasonable compensation.Review standard ↓HearthRC methodSee how three independent analytical approaches are used as documentation methodology.Review method ↓The recordSee what belongs behind the number when the position needs to be explained later.Review record ↓Calculator vs. reportSee why entity modeling and reasonable-compensation documentation are different jobs.Compare ↓
The IRS standard

Start with what the shareholder-employee actually does

Current IRS guidance says an S corporation must pay reasonable compensation to a shareholder-employee for services provided to the corporation before non-wage distributions are made to that shareholder-employee. The IRS can reclassify payments as wages when compensation is unreasonably low.

IRS S-Corp Compensation Guidance ↗Form 1120-S Instructions ↗

Factors the IRS identifies

The IRS currently lists these as factors that may matter. They are facts to evaluate—not a scoring formula.

Training and experience
Duties and responsibilities
Time and effort devoted
Dividend history
Payments to non-shareholder employees
Timing and manner of bonuses
Comparable-business compensation
Compensation agreements
Use of a compensation formula
Where the corporation's gross receipts come from matters.IRS guidance also looks at whether gross receipts are generated by the shareholder-employee's services, other employees, or capital and equipment. That distinction helps separate compensation for personal services from returns attributable to other labor or business assets.
The HearthRC documentation method

Three analytical approaches. One reconciled position

HearthRC uses multiple independent approaches so the final position does not rest on one benchmark or one rule of thumb. The three-approach framework is Hearth's documentation methodology—not an IRS-mandated formula.

01

Cost approach

Estimate what the business would reasonably incur to replace the shareholder-employee's actual functions with people performing comparable work.

02

Market approach

Compare compensation for relevant roles, duties, experience, location, industry, and other facts using appropriate comparable sources.

03

Income approach

Examine the business economics and the shareholder's contribution so the compensation position is considered alongside the sources of the company's receipts and returns to capital/other labor.

Why reconcile instead of average?The approaches do not necessarily deserve equal weight. The record explains why a particular method is more or less informative on the facts and how the final position was reached.
From facts to reviewed figure

The number is traceable back to the record

01 · Gather facts

Structured intake

Capture ownership, role, duties, hours, experience, business economics, staff structure, and available records.

02 · Analyze

Run independent approaches

Build each analytical view with its own source facts and working papers rather than one unsupported percentage.

03 · Reconcile

Explain the weighting

Resolve differences between the approaches and document why the final position fits the facts better than the alternatives.

04 · Review

Professional review

Professional-weight conclusions are reviewed through the professional-delivery layer identified in the applicable engagement documents before reliance.

Open the Working Intake →View a Completed Sample Intake →
The documentation

A reasonable-compensation position travels with the record behind it

The value of the methodology is not simply producing a number. It is preserving the facts, sources, analysis, and rationale needed to understand how that number was reached.

Inside the working record

  • Client and shareholder-employee facts captured through intake.
  • Comparable-compensation sources and source notes.
  • Working papers for the independent analytical approaches.
  • Weighting and reconciliation rationale.
  • Sensitivity or stress testing where changes in hours, duties, or other facts matter.

Inside the delivered package

  • Methodology narrative and documented compensation position.
  • Supporting explanation the firm can review with the client.
  • Working-paper support appropriate to the engagement.
  • Corporate-minutes language where included in the HearthRC deliverable.
  • Record that can serve as the starting point for a later refresh.
Inspect the Sample Work →Review Evidence & Proof →
Refresh when the facts move.Hearth's working practice is to revisit the position annually and when duties, hours, business economics, or other material facts change. That is an operating/documentation practice, not a claim that the IRS mandates one specific annual appraisal process.
Looking for entity-election planning instead?S-Calc models the election economics and salary sensitivity. HearthRC documents the reasonable-compensation position.
Explore S-Calc →Review HearthRC Defense →
Need the documented work product?

Move from methodology to the documented HearthRC work product

Review the sample first, or start the report path when a client needs a documented reasonable-compensation position.

Start a HearthRC Defense ReportSee Sample Work

This page is educational. It does not provide client-specific legal or tax advice, create an IRS safe harbor, or guarantee acceptance of a compensation position.