S Corp Owners Must Set Reasonable Salary Before Taking Distributions
Accounting expert David Riggs outlines IRS rules on S corp compensation, warning owners that salary decisions require documented support.
S corporation owners who draw income from their businesses cannot simply take shareholder distributions without first paying themselves a reasonable salary, according to accounting expert David Riggs, writing in HelloNation. The distinction carries significant tax consequences because distributions are not subject to payroll taxes, while wages are — creating an incentive the IRS actively monitors.
Riggs identifies several factors that determine what constitutes a reasonable salary for a working S corp owner: the duties performed, the owner's experience and qualifications, hours worked, and what comparable businesses pay for similar roles. Those benchmarks are not merely guidelines — they form the documentary foundation an owner would need to defend a compensation figure during an IRS examination.
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The underlying issue is one of compliance versus strategy. Because S corp distributions bypass self-employment and FICA taxes, owners who set artificially low salaries and take most of their income as distributions risk reclassification by the IRS, potentially triggering back taxes, interest, and penalties. Riggs emphasizes that supporting records are not optional; they are the difference between a defensible position and a costly audit finding.
The guidance is particularly relevant for small-business owners who may be unaware that the S corp structure, while offering legitimate tax advantages, comes with specific obligations around owner compensation. Financial and legal advisors generally recommend documenting the salary-setting process annually and revisiting it whenever the owner's role or market conditions change.
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