What is a “reasonable salary” for an S-Corp owner?

A reasonable salary is what you would earn for performing the same services for another employer under similar circumstances. The IRS requires shareholder-employees to pay themselves a reasonable salary before taking profit distributions.

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Why does the IRS require a reasonable salary?

To prevent tax avoidance. Salary is subject to payroll taxes (Social Security and Medicare), while distributions are not. Paying only distributions can trigger IRS audits, reclassification of income, and penalties.

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How do I determine a reasonable salary?

Consider:

• Industry pay standards (BLS, Glassdoor, PayScale).

• Your training, experience, and responsibilities.

• Time devoted to the business.

• Comparable roles in similar businesses.

Document your process and keep supporting data for IRS audits.

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Is there a minimum salary requirement?

No. The IRS does not set a minimum dollar amount. However, if you take distributions, you must pay yourself a reasonable salary first. If the business earns little or no income, paying no salary can be acceptable.

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How are distributions taxed?

Distributions themselves are not subject to payroll taxes. You report them on your individual return using Schedule K-1.

• S-Corp income is taxed when it passes through to you, not when you take distributions.

• Distributions are usually tax-free up to your stock basis. Any amount above basis is taxed as a capital gain.

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Can I split income using the 60/40 or 50/50 rule?

These rules are common but arbitrary. The IRS expects salary to reflect fair market value for your work, not a fixed percentage of revenue.

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What happens if I pay myself too little?

The IRS can reclassify distributions as wages, leading to back payroll taxes, penalties, and interest. Cases like Barron v. Comm’r and Watson v. United States show significant penalties for underpayment.

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How often should I pay myself?

You can choose weekly, biweekly, monthly, or quarterly. Many owners pay a base salary and issue bonuses later. Distributions can be taken anytime, provided you maintain adequate basis and cash flow.

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What if I perform multiple roles?

Estimate time spent on each role and use salary data for each. If that’s too complex, base your salary on the primary role you perform.

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Do I need payroll services?

Yes, if you want compliance and simplicity. Services like Gusto or an accountant can handle payroll taxes, W-2 filings, and unemployment tax requirements.

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Can an S-Corp owner collect unemployment?

Possibly, but it’s difficult if you continue operating the business. Rules vary by state, and eligibility often depends on whether you are truly separated from employment.

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What forms do I file for salary and distributions?

• Salary: Reported on Form W-2 and your Form 1040.

• Distributions: Reported on Form 1120-S and Schedule K-1.