Under IRC §162, reasonable compensation paid to employees is fully deductible. This includes salaries, hourly wages, bonuses, commissions, and fringe benefits. Compensation must be reasonable -- excessive salaries to owner-employees in an S-Corp can be challenged by the IRS.
Getting the deduction right is not just about whether it is allowed — it is about how you set it up.
Employees must perform actual services for the business.
Maintain payroll records, W-2s, and employment agreements.
Run payroll through a payroll service. Issue W-2s. Deduct on entity return.
S-Corp owners must pay themselves a reasonable salary before taking distributions.
Hire your children (under 18) in a sole proprietorship -- wages are deductible and exempt from FICA taxes.
When structured correctly, this deduction can significantly reduce your taxable income.
Here is how this deduction typically works in real situations:
A sole proprietor hires a part-time assistant at $20,000/year.
An S-Corp pays employees $500,000 in total wages.
S-Corp owner pays $0 salary and takes all income as distributions.
Key Takeaway: The difference between a valid deduction and a denied one usually comes down to documentation, usage percentage, and proper structuring. The same expense can be fully deductible, partially deductible, or not deductible at all — depending on how it is handled.
Yes -- reasonable employee compensation is fully deductible under IRC §162.
Yes -- in a sole proprietorship, wages paid to children under 18 are deductible and exempt from FICA taxes.
