How S Corp Owners Should Set Salary vs. Distributions
Accounting expert David Riggs outlines IRS rules on S corp reasonable compensation and why documentation is critical for owner-employees.
S corporation owners who work in their businesses face a specific IRS requirement: 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 salaries are subject to payroll taxes while distributions are not, creating an incentive the IRS closely scrutinizes.
Riggs identifies several factors that determine what counts as reasonable compensation, including the owner's job duties, professional experience, hours worked, and what comparable businesses pay for similar roles. Failing to document those factors leaves S corp owners exposed to IRS reclassification, which can convert distributions retroactively into wages and trigger back payroll taxes, penalties, and interest.
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The analytical weight of the guidance centers on record-keeping. Supporting documentation — such as industry salary surveys, written job descriptions, and corporate minutes — can defend a compensation figure if the IRS challenges it. Without that paper trail, even a salary set in good faith can be difficult to justify in an audit.
For small-business owners who chose the S corp structure specifically to reduce self-employment tax burdens, the reasonable salary rule is the compliance pressure point most likely to draw regulatory attention. Tax professionals generally advise revisiting the salary figure annually, particularly when business revenue or the owner's responsibilities change materially.
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