How S Corp Owners Should Set Salary vs. Distributions
Accounting expert David Riggs outlines IRS rules on reasonable compensation for S corp owners and why documentation is critical.
S corporation owners who actively work in their businesses face a requirement that many overlook: they must pay themselves a reasonable salary before taking any shareholder distributions, according to accounting expert David Riggs, writing in HelloNation.
The distinction matters because of how payroll taxes apply. Salaries are subject to Social Security and Medicare taxes, while distributions are not. The IRS has long scrutinized S corps where owners take little or no salary while drawing large distributions, viewing the arrangement as a strategy to avoid payroll tax obligations.
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Riggs outlines several factors that determine what counts as reasonable compensation, including the owner's specific job duties, professional experience, total hours worked, and what comparable businesses pay for similar roles. No single formula applies universally, meaning owners must build a case tailored to their own circumstances.
Documentation is central to that case. Without supporting records that justify a chosen salary figure, an S corp owner faces significant audit risk. The IRS can reclassify distributions as wages after the fact, triggering back taxes, interest, and penalties that can quickly exceed any payroll tax savings the owner had hoped to capture.
The guidance underscores a broader principle in small-business tax planning: compensation decisions inside an S corp are not purely discretionary and carry legal weight that demands careful, ongoing attention. Continue reading at All Financial Services & Investing.
