The rule
An S-Corporation must pay its owner-employee reasonable compensation for services before distributions. There is no statutory formula. The IRS looks at what a comparable employee would earn for the same work, hours and responsibility.
How we set it
Start with market data for your role in your area (Bureau of Labor Statistics, industry surveys, job postings). Adjust for hours and for the share of profit that comes from your labor versus capital, staff or systems. Document the reasoning in a one-page memo each year.
A worked example
A consultant nets $180,000. Comparable employed consultants in Orange County earn $95,000–$115,000. Salary set at $105,000; distributions of $75,000. Payroll tax saved on the distribution: roughly $11,000. If the salary were set at $40,000, the $65,000 gap is what an examiner would reclassify.
Red flags
Salary far below distributions; salary that never changes while profit grows; no salary in a profitable year; paying salary as an annual lump sum in December. Any of these invites a look.
Retirement plans change the math
Contributions to a solo 401(k) are limited by salary. A higher salary allows a larger deductible contribution, which can outweigh a small increase in payroll tax. We run both numbers together.
Related service
We run payroll on Gusto or QuickBooks Payroll, handle new-hire reporting, quarterly 941 and DE 9 filings, W-2s and 1099s, and keep S-Corp owner salaries reasonable and documented.
Payroll →
This article is general information, not advice for your situation. Facts and thresholds change; confirm before acting.
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