Reasonable compensation is a long time issue between shareholder-employees and the IRS. If you are not filing as a "C" or "S" corporation, this discussion does not apply to you. With any other entity generating active income, if you are both an owner and employee, ALL your net income is considered compensation by the IRS. In contrast, the corporation allows you to determine salary level and dividends. By using a corporation, only the salary of an owner-employee is subject to employment taxes.

The main employment taxes are Social Security (FICA) and Medicare. They total 15.3% on the first $102,000 (2008) of salary and Medicare continues above this level on any salary at 2.9% with no cap. Actually, the corporation pays one-half of these amounts and you pay the other half. Since we are discussing a corporation you own, you will want to consider the total.  

The IRS has a history of auditing corporations that show no salaries paid.  This has been a large revenue generator for the IRS in recent years. This is like shooting fish in a barrel for them.  The IRS says the corporation cannot perform work on its own. Someone has to represent the corporation in getting the work done. So, pay yourself some sort of salary for the work you do for the corporation. 

If you haven't been paying yourself a salary from your corporation, you are just an audit waiting to happen. 

For the "C" corporation, owner-employees used to pay themselves high salaries, often using up any net profits of the company. That was because, unlike salaries, dividends are not deductible to the corporation. So, they are taxed once at the corporate level (15% to 35%) and again to the shareholder. Currently, shareholder taxes on qualified dividends are limited to 15%. Since you also own the "C" corporation, it means total taxes between the corporation and you of 30% to 50% on dividends.  

Contrast that to you receiving a salary which is deductible to the "C" corporation, but incurs employment taxes plus your personal income tax, generally totaling 30.3% to 50.3%. Though "reasonableness issues" will still exist for "C" corporation owner-employees, the IRS is unlikely to attack them since there are little additional taxes to be had. However, if no salary is paid and earnings are being held in the "C" corporation, you may expect a letter from the IRS.  

Most of you have "S" corporations for good reason. One is that as long as you pay yourself reasonable compensation, all the net earnings flow through to you without corporate level taxes or employment taxes. The net earnings are considered distributed to you for tax purposes at the end of each calendar year no matter whether they were physically distributed or not.  

The disparity in the taxes (generally 30.3% to 50.3% for salaries versus 15% to 35% for net earnings with the "S" corporation) invites closer scrutiny by the IRS. One tax attorney that has worked for the IRS says that he has never seen salaries attacked where at least 40% of the net profit was paid out in salaries.  That is just their opinion, but could be a good rule of thumb.

You may want to contact a local employment agency, provide them with a list of your management responsibilities and hours worked. Then have them put into writing what it would cost to hire a person to do what you do. Be sure to keep this paper in your corporate record book in case you need it later. Many factors are considered by the IRS and tax court in determining reasonableness of compensation, including an individual's qualifications, work involved, nature of the business, profitability of the business, business conditions, salaries in relation to dividends, comparable salaries in comparable businesses, any salary policy of the business, prior years salaries paid and pension or profit-sharing plans. There is no one single factor that determines reasonableness, but rather the all of the facts and circumstances are considered.  

Consideration will also be given to what factors generated the income. If you are the only employee and your efforts generated the income, then your salary should be high compared to a business where there are several employees helping to generate income. Of course, this could be independent contractors rather than employees.