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

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

An S corporation has to pay an owner who works in the business a reasonable salary, meaning roughly what the business would pay someone else for the same work. When that salary is questioned, the IRS fact sheet FS-2008-25 lists nine factors the courts have considered: the owner's training and experience, duties, time spent on the business, the company's dividend history, pay to employees who are not owners, how bonuses were timed and paid, what comparable businesses pay, any compensation agreement, and whether a formula set the pay. The sections below explain each factor and the records that answer it.

IRS Fact Sheet FS-2008-25, "Wage Compensation for S Corporation Officers", published in August 2008, sets out its own nine-factor list for judging an S-corp owner's salary, and the IRS still lists the same nine factors on its S corporation compensation page. The fact sheet credits the factors to "the various courts that have ruled on this issue" and names no case; the broader multi-factor approach traces to Mayson Mfg. Co. v. Commissioner, 178 F.2d 115 (6th Cir. 1949). Behind all of it sits Treas. Reg. §1.162-7(b)(3), which defines reasonable compensation as "such amount as would ordinarily be paid for like services by like enterprises under like circumstances."

The Reasonable Compensation Job Aid for IRS Valuation Professionals, issued in October 2014, is the IRS's internal guide for its valuation specialists on doing that evaluation, and the IRS says plainly that it "cannot be used, cited, or relied upon" as law. The Job Aid organizes its own factor discussion under five broader areas, then turns to valuation method, ranking the market approach first as the most commonly used, the income approach second, and the cost approach last. It also tells examiners that reasonable compensation "is generally determined as a range rather than a specific number."

The nine factors at a glance

Fact Sheet FS-2008-25 gives them in this order. The courts that have ruled on the issue, it says, "based their determinations on the facts and circumstances of each case," and the court in Mayson said the situation "must be considered as a whole with no single factor decisive."

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

Four of the nine (training and experience, duties, time devoted to the business, and what comparable businesses pay) can be answered with published wage data. How a reasonable compensation report addresses the factors explains which, and the sample report shows the finished document.

Key Takeaways

• The nine factors come from IRS Fact Sheet FS-2008-25, and the courts apply their own multi-factor tests alongside it.
• 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."
• Each of the nine needs an answer with a document behind it, and that document should carry a date, a figure and the source the figure came from.
• Factor 9, "the use of a formula," does not say which way it cuts, and a salary set as a percentage of profit still has to match what the work is worth.
• The underlying legal standard did not move in 2025 or 2026. Reasonable compensation is still "such amount as would ordinarily be paid for like services by like enterprises under like circumstances" (Treas. Reg. §1.162-7(b)(3)), and in Clary Hood (4th Cir. 2023) the Tax Court found the IRS's expert most persuasive because his comparison to industry standards was well reasoned.

Where the nine factors come from

FS-2008-25, "Wage Compensation for S Corporation Officers," says outright that "There are no specific guidelines for reasonable compensation in the Code or the Regulations," and then gives "some factors considered by the courts in determining reasonable compensation." That list was never meant to be closed, and the courts apply their own tests alongside it: the Elliotts five-factor test, covering 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).

The fact sheet is still the document to work from: it is the IRS's own public list of the factors courts have considered, and it is short enough to answer factor by factor. The Job Aid reads best next to it, for the valuation methods the IRS's specialists use to put a number on the answer and for its instruction to try the market approach before anything else.

The nine factors

1. Training and experience

The IRS starts with what you brought to the job, meaning degrees, professional certifications, specialized training, licenses and years in the field. A CPA twenty years into practice does not command what someone who passed the exam last spring does.

Write this down with the specificity a résumé would use, because this factor sets the baseline for what your labor is worth on the open market. Write "15 years of experience in commercial real estate development" and an examiner knows which wage table to open. Name each license and certification rather than describing yourself as credentialed, and give the numbers, the issuing state and the year each one was earned. A reader can check every one of those in a minute, and together they tell an examiner which occupation your work belongs under.

2. Duties and responsibilities

Factor 2 is about the work itself, whatever the title on the letterhead says: the bookkeeping, the hiring, the selling, the client meetings, the delivery, sweeping the floor at closing time. Describe those duties so that someone outside the business could picture your week. "Managing a team of 4 employees, handling client acquisition, overseeing project delivery, and managing accounts receivable" gives an examiner something to match against the market.

Factor 2 also decides which market data applies to you at all, because most S-corp owners wear several hats over the course of a week. That is why the Cost Approach, which prices each of those hats independently, is useful, and Cost Approach vs. Market Approach covers how the two methods differ.

3. Time and effort devoted to the business

Sean McAlary Ltd., Inc. v. Commissioner, T.C. Summary Opinion 2013-62, shows the arithmetic this factor drives, because the IRS expert and the Tax Court built the salary the same way, as an hourly wage multiplied by 2,080 hours, which is 40 hours across 52 weeks. The expert took the median wage for real estate brokers in southern California from state Occupational Employment Statistics (now OEWS) data, $48.44 an hour, and arrived at $100,755. The court kept the 2,080-hour structure, found $40 an hour reasonable given this broker's limited experience and the company's modest operations, and set compensation at $83,200. The company had paid him no wages that year, while $240,000 moved from its account to his.

The same hourly value produces a very different annual salary at 15 hours a week than at 50, so state your typical week, and say so plainly if it swings with the season or the project cycle. Fewer hours should pull your figure down proportionally. Hours past 2,080 are treated differently from case to case: in McAlary the IRS expert priced a standard 40-hour week even though the owner often worked seven days a week, while in Miller & Sons Drywall, Inc. v. Commissioner (T.C. Memo. 2005-114) the Tax Court priced two owners' work on a 55-hour week. If your week does swing, give the range and name the months each end of it applies to, so the hours in your file are tied to a stretch of the calendar rather than to an average nobody can place.

Hours are easy to record while the year is running and hard to reconstruct once a letter arrives, so put a calendar, payroll records, or a line in the annual minutes recording a 45-hour week into the file now, while the week it describes is still the current one.

4. Dividend history

Factor 4 looks at salary against distributions, year after year, and a history of $200,000 in distributions alongside $30,000 in salary tells the IRS something about that salary before anyone opens a wage table. Be straight about that history in your documentation. If the ratio has been aggressive, say what has changed since, whether that is a new analysis, a documented methodology, or a salary reset against market data, and give the year you made the change. The pattern carries more weight than any single year, so pull three or four years of salary and distribution figures into one table and let the trend show for itself.

Large distributions next to a small salary are a common trigger for a 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 for him while his accounting firm paid the S corporation $203,651 for 2002 and $175,470 for 2003, and the S corporation passed what was left to him as dividends. The courts sided with the IRS, treated the wages as unreasonably low, and reclassified part of the distributions as compensation on the strength of an IRS expert who valued the CPA's services at $91,044 a year. That $91,044 became the reasonable figure.

Distribution history is also a factor you cannot amend after the fact. Reset the salary on documented data and let the next few returns establish the new pattern.

5. Payments to non-shareholder employees

Factor 5 is your own payroll. A non-owner operations manager at $90,000 sitting next to an owner at $40,000 who does that job and more is an internal comparison the IRS can make without leaving your payroll records, and those are the wages your own business pays for the work, which is harder to argue with than a national survey average.

Put the compensation of any employee doing comparable work in the file, and if you are a solo S corp, say so rather than leaving the factor blank. Where the comparison runs the other way, and your own pay sits well above what you pay a manager doing much of the same work, give the reason, whether that is supervision, client ownership, or the personal guarantee on the credit line.

6. Timing and manner of paying bonuses to key people

The fact sheet's exact wording is "timing and manner of paying bonuses to key people." The question behind it is whether a bonus to a shareholder-employee tracks performance or tracks the distribution schedule. A year-end bonus that rounds total compensation to a tidy number just before a large distribution reads as a distribution wearing a different label. Timing is the part of this factor owners forget, and a bonus declared and paid in the same week a large distribution goes out invites exactly the question the factor was written to ask.

Document the basis for any bonus you pay yourself, whether that is a profitability milestone, a completed project, or an annual performance review, and put the date and the approval in the same memo. If you pay none, a single sentence saying so closes the factor.

7. What comparable businesses pay for similar services

This factor is market data, and most of a reasonable compensation analysis sits inside it. What would you have to pay someone with your skills to do your job where you do it?

Cite the source, the year, and the cut you took. The Bureau of Labor Statistics Occupational Employment and Wage Statistics (OEWS) program is free and public, and IRS experts have used it in Tax Court cases; in McAlary the IRS expert took his $48.44 hourly median for brokers from state OEWS data, and the court weighed that evidence with the broker's limited experience and the company's modest operations. OEWS publishes annual estimates for about 830 occupations across about 530 metropolitan and nonmetropolitan areas, and the most recent release is the May 2025 data set, published in 2026. Make the occupation code, the geographic area, the data year, and the experience-level percentile you used traceable, so an examiner can walk from your duties to your salary figure without having to ask you for anything.

The percentile deserves as much thought as the occupation code. A 25th-percentile wage suits an owner a year or two into the trade, and a 75th suits one with a decade and a book of business behind them. State why you chose the one you did.

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, and held the owner's claimed compensation excessive. The Fourth Circuit affirmed the deficiency but vacated the §6662 accuracy penalty, because the company had relied in good faith on the tax advisors who approved its catch-up-pay plan. Clary Hood is a C-corp case, and the evidence the court credited, comparable pay data whose sources, methods and calculations were disclosed, is the evidence an S-corp owner has to bring too.

8. Compensation agreements

Factor 8 asks for a written record of the decision, which means a board resolution, even in a corporation whose board is you, that names the salary, points to the analysis behind it, and gets filed with the corporate minutes. It takes 10 minutes, and WageProof's report includes sample resolution language for exactly this purpose.

A resolution that states a bare number is weaker than one naming the analysis behind it, the date it was run, and the data year it relied on. A resolution passed before the year begins carries weight that an analysis produced after the first IRS letter never will.

9. The use of a formula to determine compensation

The fact sheet lists factor 9 without saying which way it cuts. Courts have treated a pay formula that a company set in advance and applied for years as evidence the pay was reasonable, in cases where the IRS said a corporation had paid too much (Mayson; Elliotts). Setting your own salary as "60% of net income" or "50% of distributions" is not that: it hands the IRS an arbitrary formula applied to a business it knows nothing about, and the percentage says nothing about what your work is worth. Formulas are appealing because they are quick and they run the same way every year.

Treas. Reg. §1.162-7(b)(3) ties the answer to "like services by like enterprises under like circumstances," a test about duties and markets rather than about a share of the company's profit. A consulting firm at $500,000 in revenue and a trucking company at $500,000 in revenue have nothing in common in what their owner-operators are worth, and a percentage treats them as identical. If someone tells you the "60/40 rule" is an accepted methodology, they're wrong.

Where documentation earns its keep

Comparable salaries (#7) is the factor courts have called "a most significant factor," and if the file holds no market data for your role and area, the examiner's is the only analysis in the room. In McAlary the court disagreed with the IRS expert on the rate: it weighed the wage statistics in his report with the broker's limited experience and the company's modest operations, and held an hourly rate of $40 rather than his $48.44. Which market data applies at all comes back to duties and responsibilities (#2), since an examiner's real question is what you did all day. A broker running listings, as in McAlary, and a CPA running an accounting practice, as in Watson, are priced off different tables, and the duties description is what decides which table gets opened.

Dividend history (#4) does something else again. It rarely sets the correct number, but an extreme salary-to-distribution ratio is a common trigger for the challenge in the first place, and it sits on the face of the return where an examiner is already looking.

What's changed for 2025–2026

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 set.

The framework around that data sits where it was. The nine factors, the fact sheet and the §162 standard underneath them are all current, the IRS still publishes the 2014 Job Aid on its website, and no statute, regulation, or Supreme Court decision has rewritten how a salary gets judged. McAlary, Watson, and the C-corp counterpart Clary Hood, affirmed by the Fourth Circuit in 2023, all came out against the pay the company had set, with the court weighing the market pay data in an expert's documented report; in McAlary the court also set a lower hourly rate than the IRS expert's.

All of it surfaces on the return. Your salary is reported on line 7 of Form 1120-S, "Compensation of officers," and an S corporation with total receipts of $500,000 or more also attaches Form 1125-E, which lists each officer's pay, share of time and share of stock. Your distributions are reported on the same return, on Schedule K, line 16d.

How a reasonable compensation report addresses the factors

A well-built report leaves a trail through the factors it can reach. It asks for the tasks you actually perform and the share of your working hours each one takes (factors 2 and 3), matches those tasks to BLS wage data for your county's BLS wage area (factor 7), and turns your years of experience at each task into an experience level that sets which BLS percentile applies (factor 1). Those are the four of the nine that a wage study can answer with published data. The reasonable salary calculator shows how WageProof runs those steps.

The other five are company-specific: dividend history, payments to other employees, bonus patterns, existing compensation agreements, and whether a formula set the pay. Those stay your CPA's call, and the report gives them the wage data to make it on. Reasonable compensation reports for CPAs and EAs give the preparer that wage data for each client. Nothing stops you from answering them yourself, in a page of plain notes filed alongside the report, which is better than handing an examiner five of the nine with nothing under them.

WageProof's report is built on that framework, and the sample report shows the finished document, with the arithmetic and the data vintages behind it published on our methodology page.