S Corp Owners Must Set Reasonable Salary Before Taking Distributions
Accounting expert David Riggs outlines IRS rules on S corp owner compensation, explaining how salary decisions affect payroll taxes and require documentation.
S corporation owners who work in their businesses cannot simply take shareholder distributions without first paying themselves a reasonable salary, according to guidance from accounting expert David Riggs published in HelloNation. The distinction carries significant payroll tax consequences and sits squarely in the IRS's enforcement crosshairs.
Riggs explains that several factors determine what qualifies as reasonable compensation, including the owner's specific duties, professional experience, hours worked, and what comparable businesses pay for similar roles. These benchmarks matter because the IRS scrutinizes arrangements where owners minimize salary — and therefore minimize payroll taxes — while maximizing lower-taxed distributions.
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The structure of S corp compensation is central to its tax appeal. Salaries are subject to Social Security and Medicare payroll taxes, while shareholder distributions generally are not. That gap creates an incentive for owners to suppress wages, which regulators have long recognized as an area of potential abuse. Riggs stresses that any salary decision must be backed by supporting documentation, not just a number chosen for convenience.
From a compliance standpoint, the reasonable salary requirement is not optional. The IRS can reclassify distributions as wages if an owner's compensation appears artificially low relative to the services provided, triggering back payroll taxes, penalties, and interest. Maintaining contemporaneous records that justify the salary figure is therefore a practical necessity, not merely good practice.
Business owners operating as S corporations — particularly those in professional services — should periodically review their compensation structure as revenues and responsibilities change. Continue reading at All Financial Services & Investing.
