Paying yourself through an S-Corp can be one of the most effective tax strategies available to business owners. It also comes with a responsibility the IRS takes seriously: the salary you pay yourself has to be reasonable. A salary that was reasonable when you set it may not be reasonable today.
Why the IRS Watches Closely
Wages are subject to Social Security and Medicare taxes, and S-Corp distributions aren’t. That gives owners an incentive to keep salary low and distributions high, and the IRS knows it. When an owner’s pay looks out of step with the work they perform, the IRS can reclassify distributions as wages and add back payroll taxes, penalties, and interest.
What “Reasonable” Actually Means
There’s no fixed formula. Instead, the IRS looks at factors such as:
- Your training and experience
- Your duties and responsibilities
- The time and effort you devote to the business
- Your distribution history
- What the business pays non-owner employees
- What comparable businesses pay for similar services
Why Your Number May Need a Second Look
A salary that made sense in a leaner year can drift out of alignment as revenue climbs, your team grows, or your role changes. A salary that was proportionate when profits were modest can look very different next to distributions that have grown several times over.
Why Now Is the Time
Once the year’s final payroll runs, your options narrow. Reviewing compensation in November leaves room to adjust December payroll if needed. It’s also a good time to confirm that health insurance premiums the business pays for you are reported as wages on your W-2, as required for shareholder-employees who own more than 2% of the company. And because W-2 wages affect your Qualified Business Income deduction, the right salary figure matters in more than one place.
Documentation Is Your Best Defense
A salary figure backed by market data and a clear record of how you arrived at it is far stronger than one chosen out of habit. That documentation turns a potential audit question into a straightforward answer.
Your Next Step
If you haven’t revisited your salary since you first set it, a year-end review is a smart checkpoint. We’ll help you land on a figure that holds up and makes sense for your business.
Let us lighten your load.
