S Corp Owners Must Set Reasonable Salary Before Taking Distributions

S corporation owners who also work in their businesses face a tax compliance requirement that can carry significant consequences if ignored: they must pay themselves a reasonable salary before taking 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 generally are not. The IRS has long scrutinized S corp owners who take little or no salary and instead draw most of their compensation as distributions, a strategy that reduces payroll tax liability but can trigger audits and penalties if the salary is deemed unreasonably low.

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Riggs explains that determining what qualifies as reasonable compensation is not arbitrary. Relevant factors include the owner's specific duties within the company, their level of experience and expertise, the number of hours worked, and what a comparable business would pay an unrelated employee to perform the same role. Together, these criteria form the basis of a defensible salary figure.

Documentation is central to the guidance Riggs provides. Maintaining supporting records — such as job descriptions, industry wage surveys, and board minutes approving compensation — helps substantiate salary decisions in the event of an IRS inquiry. Without such records, owners risk having their compensation structure reclassified, resulting in back payroll taxes, interest, and penalties.

For small business owners weighing the tax advantages of the S corp structure, the takeaway is that the salary-versus-distribution balance requires deliberate planning and ongoing recordkeeping rather than a one-time decision. Continue reading at All Financial Services & Investing.