How S Corp Owners Should Set Reasonable Salary vs. Distributions
Accounting expert David Riggs outlines how S corp owners must balance reasonable compensation with shareholder distributions to stay IRS-compliant.
S corporation owners who actively work in their businesses face a legal requirement to pay themselves a reasonable salary before taking any shareholder distributions, according to accounting expert David Riggs, writing in HelloNation. The distinction carries significant financial consequences because salaries are subject to payroll taxes while distributions generally are not, creating an incentive the IRS monitors closely.
Riggs identifies several factors that determine what qualifies as reasonable compensation, including the owner's specific job duties, professional experience, hours worked, and what comparable businesses pay for similar roles. Without documentation supporting the salary figure chosen, S corp owners risk IRS scrutiny that could reclassify distributions as wages, triggering back taxes and penalties.
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The underlying tension in S corp compensation planning stems from competing interests: owners naturally prefer lower salaries to reduce payroll tax exposure, but federal tax authorities expect salaries that reflect the market value of the work being performed. Riggs emphasizes that the records supporting a salary decision are as important as the number itself, making documentation a core compliance task rather than an afterthought.
For small business owners structured as S corporations, the reasonable salary requirement is one of the most consequential ongoing obligations they face. Getting it wrong — either by paying too little or failing to maintain supporting records — can undermine the tax advantages the S corp structure is designed to provide.
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