How S Corp Owners Should Set Reasonable Salary vs. Distributions
Accounting expert David Riggs outlines why S corp owners must pay themselves a reasonable salary before taking shareholder distributions to satisfy IRS rules.
S corporation owners who work in their businesses face a tax obligation that other shareholders do not: they must pay themselves a reasonable salary before drawing any shareholder distributions, according to accounting expert David Riggs, writing in HelloNation.
The distinction matters because salaries are subject to payroll taxes — Social Security and Medicare — while distributions are not. The IRS has long scrutinized S corps where owner-operators take little or no salary and instead extract most of their compensation as distributions, a strategy that reduces payroll tax liability but can trigger audits, penalties, and back taxes if the salary is deemed unreasonably low.
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Riggs identifies several factors the IRS and courts weigh when evaluating whether compensation is reasonable: the owner's specific duties within the company, relevant experience and qualifications, the number of hours worked, and what comparable businesses pay employees performing similar roles. No single factor is determinative, and the analysis is inherently fact-specific, making documentation critical.
Maintaining supporting records is a central theme of Riggs's guidance. Owner-operators are advised to keep written records that justify their salary decisions — including wage surveys, industry compensation data, and contemporaneous notes on job responsibilities. Without such documentation, defending a salary figure against IRS scrutiny becomes significantly harder, regardless of whether the amount itself was reasonable.
For small-business owners structured as S corporations, the stakes extend beyond a single tax year. An IRS reclassification of distributions as wages can result in unpaid payroll taxes, interest, and penalties reaching back multiple years. Riggs's analysis underscores that proactive salary-setting, grounded in comparable market data and documented thoroughly, is both a compliance requirement and a risk-management practice. Continue reading at All Financial Services & Investing.
