How S Corp Owners Should Set Salary vs. Distributions

Small business owners operating as S corporations face a critical tax decision: how much to pay themselves as salary versus how much to take as shareholder distributions. According to accounting expert David Riggs, getting that balance wrong can trigger IRS scrutiny and significant payroll tax liability.

The IRS requires working S corporation owners to receive what it considers "reasonable compensation" before any distributions are taken. Riggs explains that the standard is not arbitrary — it is anchored to concrete factors including the owner's specific duties, years of experience, hours worked, and what comparable employees in similar roles earn in the open market.

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The distinction matters because salaries are subject to payroll taxes, including Social Security and Medicare, while shareholder distributions generally are not. Some S corp owners have historically attempted to minimize their salary and maximize distributions to reduce their overall payroll tax burden. The IRS views this practice as a red flag and has pursued cases where compensation appeared unreasonably low relative to the work performed.

Riggs emphasizes that documentation is not optional — it is essential. Business owners need supporting records that justify their compensation decisions, including comparability data, job descriptions, and time logs. Without that paper trail, owners are exposed if the IRS challenges their salary structure during an audit. A defensible reasonable salary determination protects the tax advantages of the S corp structure while keeping the owner in compliance.

For S corp owners uncertain about where to set their compensation, consulting a qualified tax professional before year-end can prevent costly adjustments later. Continue reading at All Financial Services & Investing.