The 9 IRS Factors (FS-2008-25) & the Job Aid

Part of WageProof's complete guide to S-corp reasonable compensation.

The IRS uses nine factors to evaluate whether an S-corp owner's salary is reasonable. They come from IRS Fact Sheet FS-2008-25, "Wage Compensation for S Corporation Officers", published in August 2008, and they're still the primary framework that IRS examiners and Tax Court judges use today. The factors are not invented by the IRS — they were "fleshed out over the years in numerous court decisions" (most notably Mayson Mfg. Co. v. Commissioner, 178 F.2d 115 (6th Cir. 1949)) and they trace back to the statutory standard in Treas. Reg. §1.162-7(b)(3): reasonable compensation is "such amount as would ordinarily be paid for like services by like enterprises under like circumstances." If you're setting your own salary or advising a client, every one of these factors should be addressed in your documentation.

The IRS Job Aid. Alongside FS-2008-25, there is a second document that shows how examiners develop the reasonable compensation issue: the Reasonable Compensation Job Aid for IRS Valuation Professionals (October 2014). The Job Aid is a separate internal IRS training document — the IRS expressly states it "cannot be used, cited, or relied upon" as law — and it does not restate FS-2008-25's nine factors; instead it organizes its own factor discussion under five broader areas and reveals exactly which valuation methods examiners are taught to prefer. Critically, the Job Aid ranks the market approach first as the most commonly used method, the income approach second, and the cost approach last. It also emphasizes that reasonable compensation "is generally determined as a range rather than a specific number." Understanding the Job Aid helps you see how an IRS examiner will read your documentation — and what they will be looking for.

The nine factors at a glance

The IRS evaluates reasonable compensation using nine factors from Fact Sheet FS-2008-25. No single factor is determinative — examiners weigh all nine on the totality of the facts and circumstances:

1. Training and experience
2. Duties and responsibilities
3. Time and effort devoted to the business
4. Dividend history
5. Payments to non-shareholder employees
6. Timing and manner of paying bonuses
7. What comparable businesses pay for similar services
8. Compensation agreements
9. Use of a formula to determine compensation — a negative factor; percentage rules of thumb work against you

Each factor is explained in detail below, with what the IRS looks at and how to document it.

Key Takeaways

• The IRS evaluates reasonable compensation using nine factors from Fact Sheet FS-2008-25, plus additional factors developed through court decisions.
• No single factor is determinative. The IRS looks at the totality of the facts and circumstances. The IRS's own Reasonable Compensation Job Aid for IRS Valuation Professionals tells examiners that reasonable compensation "is generally determined as a range rather than a specific number."
• The factors that decide most cases: duties performed, comparable salaries, and training/experience.
• A strong report should address each factor with specific evidence, not just list them as references.
• Factor #9, "the use of a formula," is a negative factor. Percentage-based rules of thumb work against you.
• The underlying legal standard never changed in 2025–2026: reasonable compensation is "such amount as would ordinarily be paid for like services by like enterprises under like circumstances" (Treas. Reg. §1.162-7(b)(3)). Recent appellate cases (Clary Hood, 4th Cir. 2023) confirm that the win goes to whoever brings transparent, industry-specific comparable data.

Where the nine factors come from

IRS Fact Sheet FS-2008-25, titled "Wage Compensation for S Corporation Officers," states plainly that "There are no specific guidelines for reasonable compensation in the Code or the Regulations," and then lays out "some factors considered by the courts in determining reasonable compensation." The word "some" is important. The IRS is deliberately non-exhaustive. Courts have developed additional factor tests over the years, notably the Elliotts five-factor test — role in the company, external comparison, character and condition of the company, conflict of interest, and internal consistency (716 F.2d 1241, 9th Cir. 1983) — and the multi-factor test applied in Brewer Quality Homes (T.C. Memo 2003-200), which traces to Mayson Mfg. Co. (6th Cir. 1949) and Owensby & Kritikos, Inc. v. Commissioner (819 F.2d 1315, 5th Cir. 1987).

But FS-2008-25 remains the primary reference. It's what IRS examiners are trained on, and it's what Tax Court opinions cite most frequently. A second IRS document worth knowing is the Reasonable Compensation Job Aid for IRS Valuation Professionals (issued October 2014). It is not authority — the IRS expressly says it "cannot be used, cited, or relied upon" as law — but it shows examiners how to develop the issue. It does not restate FS-2008-25's nine factors — instead it organizes its own factor discussion under five broader areas, ranks the three valuation methods (the market approach "is the most commonly used method," the income approach next, and the cost approach "the least used"), and stresses that the answer "is generally determined as a range." If your documentation addresses all nine factors and lands inside a defensible range, you're covering the framework the IRS expects to see.

The nine factors

1. Training and experience

What the IRS looks at: Your education, professional certifications, specialized training, and years of experience in your field. A CPA with 20 years of practice commands different compensation than someone who just passed the exam. An electrician with a master's license is valued differently than an apprentice.

How to document it: State your relevant degrees, certifications, licenses, and years of industry experience. Be specific. "15 years of experience in commercial real estate development" is stronger than "experienced business owner."

Why it matters: This factor establishes the baseline for what your labor is worth in the market. More training and experience generally justifies higher compensation.

2. Duties and responsibilities

What the IRS looks at: What you actually do in the business. Not your title, not your aspirations. The specific tasks you perform on a regular basis. Are you doing bookkeeping? Managing employees? Selling? Consulting with clients? Sweeping the floor?

How to document it: List your duties with enough specificity that someone outside the business could understand your role. The more granular, the better. "General management" is weak. "Managing a team of 4 employees, handling client acquisition, overseeing project delivery, and managing accounts receivable" is strong.

Why it matters: This is one of the two factors that decide most cases. The IRS wants to match what you do to what the market pays for that work. Most S-corp owners wear many hats, which is exactly why the Cost Approach (which prices each task independently) is useful. See Cost Approach vs. Market Approach for more on how this works.

3. Time and effort devoted to the business

What the IRS looks at: How many hours per week you work in the business. Full-time? Part-time? Seasonal?

How to document it: State your typical weekly hours. If it varies by season or project cycle, explain that. An owner working 50 hours a week has a different compensation profile than one working 15.

Why it matters: Time is a multiplier. The same hourly value applied over different hours produces different annual compensation. The standard worked example is Sean McAlary Ltd., Inc. v. Commissioner (T.C. Summary Op. 2013-62), where both the IRS expert and the Tax Court built the salary the same way: an hourly wage multiplied by 2,080 hours (40 hours x 52 weeks). The IRS expert used the median wage for real estate brokers in southern California (drawn from state Occupational Employment Statistics — now OEWS — data) of $48.44/hour, for $100,755. The court agreed with the 2,080-hour structure but found $40/hour reasonable, arriving at $83,200. Note what the court did not do: it didn't accept the owner's reported figure of $0 in wages on $240,000 of distributions. If you work fewer hours, your compensation should be proportionally lower. If you work more, the additional hours above 2,080 don't typically increase the figure because the standard caps at full-time equivalent.

4. Dividend history

What the IRS looks at: Your pattern of salary versus distributions over time. This is the red flag factor. If you've been taking $200,000 in distributions and paying yourself $30,000 in salary for years, that pattern tells the IRS your salary probably isn't reflecting the real value of your work.

How to document it: Be honest about your distribution history. If the ratio looks aggressive, acknowledge that and explain what's changed (new analysis, better documentation, adjusted salary based on market data). The worst thing you can do is ignore this factor when your numbers tell an obvious story.

Why it matters: Large distributions paired with a small salary is the most common trigger for an IRS challenge. In David E. Watson, P.C. v. United States (668 F.3d 1008, 8th Cir. 2012), a CPA's S corporation reported wages of $24,000 a year while distributing roughly $204,000 (2002) and $175,000 (2003). The courts sided with the IRS, treating the wages as unreasonably low and reclassifying a chunk of the distributions as compensation. The IRS expert valued the CPA's services at $91,044 a year — and that became the reasonable figure. Your documentation should show that your salary reflects the market, independent of how much you're distributing.

5. Payments to non-shareholder employees

What the IRS looks at: What you pay other employees who do similar work. If you have a non-owner operations manager making $90,000 and you're paying yourself $40,000 while performing the same duties plus more, that's hard to justify.

How to document it: If you have employees performing comparable work, note their compensation. If you have no employees — many S-corps are solo — this factor is less relevant. Say so explicitly anyway.

Why it matters: Internal comparables are strong evidence. They're harder for the IRS to dispute than external market data because they reflect what your specific business actually pays for the work.

6. Timing and manner of paying bonuses to key people

What the IRS looks at: The fact sheet's exact wording is "timing and manner of paying bonuses to key people." The question is whether bonuses to shareholder-employees correlate with performance, or whether they look like disguised distributions. A year-end bonus that conveniently brings total compensation to a round number right before large distributions looks like a disguised distribution, and an examiner will read it that way.

How to document it: If you pay yourself bonuses, document the basis for them (profitability milestones, project completion, annual performance review). If you don't pay bonuses, say so.

Why it matters: Irregular or suspiciously timed bonus payments can undermine an otherwise reasonable salary structure. Consistency and documentation matter here.

7. What comparable businesses pay for similar services

What the IRS looks at: Market data. What would you have to pay someone with your skills to do your job in your geographic area? This is the heart of any reasonable compensation analysis.

How to document it: Cite specific data sources. The Bureau of Labor Statistics Occupational Employment and Wage Statistics (OEWS) program is the gold standard. It's publicly available, it's the kind of government wage data IRS experts reach for (the McAlary court's salary was built on state OEWS broker wages), and the program publishes annual estimates for roughly 800 occupations across about 530 metropolitan and nonmetropolitan areas. The most recent release is the May 2025 data set, published in 2026. Your documentation should make the occupation codes, geographic area, data year, and experience-level (percentile) adjustments traceable so an IRS examiner can follow the path from your duties to your salary number.

Why it matters: This is one of the two factors that decide most cases, alongside duties performed. Courts have consistently ruled that data-backed analysis from recognized sources beats self-serving testimony. In Clary Hood, Inc. v. Commissioner (4th Cir. 2023) — a C-corp case applying the same §162(a)(1) reasonable-compensation standard — the Tax Court found the IRS's expert most persuasive because he applied the multi-factor test with a well-reasoned comparison to industry standards; the owner's claimed compensation was held excessive. The Fourth Circuit affirmed the deficiency but vacated the §6662 accuracy penalty, because the company had relied in good faith on tax advisors who approved its catch-up-pay plan. The lesson cuts both ways — whether you're an S-corp owner defending a salary that may be too low or a C-corp owner defending one that may be too high, transparent comparable data is what wins.

8. Compensation agreements

What the IRS looks at: Whether there's a formal written agreement or board resolution documenting the compensation decision. Did the board (even if it's just you) formally approve the salary based on a documented analysis?

How to document it: Pass a board resolution that sets the salary amount, references the market data or analysis used, and gets filed with your corporate minutes. It takes 10 minutes and is one of the cheapest ways to strengthen your position. Many reasonable compensation reports include template resolution language for exactly this purpose.

Why it matters: Contemporaneous documentation is much stronger than an analysis produced after the IRS starts asking questions. A board resolution shows you thought about this proactively.

9. The use of a formula to determine compensation

What the IRS looks at: Whether you used an arbitrary formula or percentage to set your salary. And this is a negative factor. If you set your salary as "60% of net income" or "50% of distributions," you're making the IRS's case easier.

How to document it: Don't use a formula. The IRS and Tax Court have explicitly rejected percentage-based approaches. Your salary should be based on market data for your specific role, area, and experience, not on a ratio of revenue or profit. If someone tells you the "60/40 rule" is an accepted methodology, they're wrong.

Why it matters: This factor exists specifically because the IRS knows that formula-based approaches are often used to justify artificially low salaries. A consulting firm at $500,000 in revenue and a trucking company at $500,000 in revenue have completely different salary profiles for their owner-operators. A percentage formula treats them identically, which is exactly the kind of lazy analysis the IRS rejects. It also runs against the regulation itself, which ties reasonable compensation to "like services by like enterprises under like circumstances" (Treas. Reg. §1.162-7(b)(3)) — a market-and-duties test, not a share of the company's profit.

Which factors matter most in practice

In Tax Court cases, three factors tend to drive outcomes:

Comparable salaries (#7) is almost always the deciding factor. If you have solid market data showing what your role pays in your area, and your salary falls within that range, you're in a strong position. If you don't have data, you're relying on the IRS examiner's analysis instead of your own.

Duties and responsibilities (#2) determine which market data applies. The IRS doesn't just ask "are you a business owner?" They ask "what do you actually do all day?" An owner who spends 40% of their time on bookkeeping, 30% on sales, and 30% on client delivery has a different market value than one who spends 100% of their time on high-level consulting.

Dividend history (#4) is the trigger factor. It's rarely the basis for setting the correct number, but an extreme salary-to-distribution ratio is often what puts you on the IRS's radar in the first place.

What's changed for 2025–2026

The legal framework has not changed — and that's the point. The nine factors, the FS-2008-25 fact sheet, the Job Aid, and the underlying §162 standard are all still current. There has been no statute, regulation, or Supreme Court decision that rewrites how reasonable compensation is judged. Three things are worth noting for a current report:

• New wage data. The BLS released its May 2025 OEWS estimates in 2026, so a report dated mid-2026 should be built on May 2025 figures rather than the older May 2024 data. Using the most recent published data year is itself a credibility signal to an examiner.
• The "transparent comparables win" pattern is hardening. The string of modern cases — McAlary, Watson, and the C-corp counterpart Clary Hood (affirmed by the Fourth Circuit in 2023) — all turned on the same thing: the side with a documented, industry-specific, market-data analysis prevailed over the side relying on assertion or a profit-based formula.
• Form 1125-E is still the disclosure point. Since tax year 2011, S corporations with total receipts over $500,000 must report officer compensation on Form 1125-E, which is where an examiner first compares your stated salary against your distributions. The Job Aid points examiners to it directly.

How a reasonable compensation report addresses the factors

A well-built report doesn't just calculate a number. It works through the factors:

• It documents your duties by asking you to select and describe your tasks (factors 2 and 3).
• It matches those tasks to BLS wage data for your metro area and experience level (factor 7).
• It adjusts for your training and qualifications through proficiency ratings tied to measurable criteria like years of experience (factor 1).
• It produces a documented methodology with source citations, not a formula-driven output (factor 9).
• It includes board resolution language for your corporate records (factor 8).

The remaining factors (4, 5, 6) are business-specific context that should be reviewed with your CPA. A good report gives your CPA the data foundation; they bring the tax planning context.

WageProof's report is built around this framework. You can see exactly how it addresses these factors in the sample report, and the full methodology is published on our methodology page.