Reasonable Salary for S-Corp Owners: How Much Should You Pay Yourself?

If your business is taxed as an S corporation and you work in it, the IRS requires you to pay yourself a reasonable salary before taking distributions. It's one of the most audited areas for small S-corps, so it's worth getting right.

Why the rule exists

S-corp distributions aren't subject to payroll taxes, but salary is. Without this rule, every owner would pay themselves $0 in salary and take everything as distributions. The IRS expects shareholder-employees to be paid fairly for the work they actually do.

What counts as "reasonable"?

There's no fixed formula or percentage in the tax code. "Reasonable compensation" is generally what the business would have to pay someone else to do the same work. The IRS and courts look at factors such as:

• Your duties, responsibilities and hours
• Your training and experience
• What comparable businesses pay for similar services
• The business's gross receipts and profit
• Compensation agreements and the company's dividend (distribution) history
• How much time you spend on the business

Ways to set your number

1. Market comparison. What would it cost to hire someone to do what you do? Use wage data for your occupation and region.

2. Break down your roles. If you spend half your time doing the work (for example, bookkeeping or repair work), a quarter managing and a quarter on sales, weight the salary by the market rate for each role.

3. Use a reasonable compensation study. Some tax professionals use specialized tools that produce a documented report.

Rules of thumb (use with caution)

You'll often hear "pay yourself 40% to 60% of profit." It's a starting point for a conversation, not a rule. A very profitable business with an owner who works part-time might justify less; an owner whose personal work generates all the revenue might need more.

Red flags for the IRS

• Salary of $0 while taking large distributions
• A tiny salary relative to profits in a business where the owner does all the work
• Distributions taken every month but payroll run once a year

Document your decision

Keep a short memo in your records: how you chose the salary, the sources you used and the date. Revisit it each year as the business grows.

How it works in practice

• Run payroll for yourself on a regular schedule (monthly or semi-monthly)
• Withhold federal income tax and FICA; your company pays the employer share
• File quarterly payroll reports and a W-2 at year-end
• Take distributions from remaining profit, and record them properly in your books

The bottom line

A defensible salary protects your S-corp savings. Set it based on real market data and your actual role, document how you chose it, and review it every year with your tax professional.

---

Need help getting this right? TRIG Bookkeeping & Tax Services helps new business owners in Washington with company registration, monthly and annual bookkeeping, and government compliance. Contact us to talk about your business.

This article is general information, not legal or tax advice for your situation. Tax rules and fees change, so confirm current details with the IRS, the Washington Department of Revenue, or a qualified professional.