Key Takeaway
Your S Corp salary must be reasonable — not too low, not exaggerated.
Here’s what to remember:
- Use real-world data to support your salary
- Consider your role, duties, experience, and location
- Ensure your business can sustain the salary amount
- Start modestly if cash flow is tight, but adjust as profits grow
- Consult a CPA or tax advisor familiar with S Corps, Form 2553, tax planning, and shareholder compensation strategies
For additional context or deeper insights, many professionals also follow resources IRS analysis on tax issues.
If you own an S Corporation (S Corp), one of the most common — and confusing — questions is:
“How much should I pay myself?”
The short answer: you must pay yourself a reasonable shareholder salary as defined by the Internal Revenue Service under current tax laws. But what’s considered reasonable? And how do you balance that with your business’s cash flow needs, payroll obligations, and payroll taxes?
Let’s break it down.
What Is a “Reasonable Salary”?
The IRS requires S Corp owners who actively work in the business to take a salary that reflects the fair market value of their services.
In other words, you should pay yourself what you would pay someone else to do your job. This standard is reinforced in IRS guidance, revenue rulings, Tax Court cases, and reasonable shareholder salary determinations.
This rule exists because some business owners try to reduce FICA tax, Social Security payroll taxes, and Medicare taxes by taking only shareholder distributions instead of employee wages on a W-2 form.
Not only the IRS but also the EDD monitor this closely — and underpaying yourself can raise red flags, trigger audits, or lead to back taxes and penalties on employment-related taxes.
How to Determine a Reasonable Salary
There’s no one-size-fits-all formula, but here are key factors the IRS, CPAs, tax advisors, and tax practice professionals consider.
Your Role and Duties:
What kind of work are you doing? (e.g., consulting, managing, client service, operations)
How much time do you spend on the business? This also ties into Material Participation standards, including logs like a Material Participation REPS Log for those with Rental Property or family farming operations.
Action item: Document your time spent, responsibilities, and level of involvement.
Industry Standards:
In what industry does your business operate?
Research what others in similar roles earn using sources like Glassdoor, Indeed, or the Bureau of Labor Statistics.
Document this research — it’s useful if the IRS ever asks how you determined your compensation strategy or reviews your return preparation software and supporting documentation.
Action item: Save salary research sources and screenshots.
Business Size and Revenue:
How much revenue and profit does your business generate?
A small business corporation generating $100,000 annually won’t support the same salary as one earning $1 million. Salary must reflect profitability and discretionary cash flow.
Action item: Compare your salary range against current business profitability.
Experience and Qualifications:
What level of skill and experience do you bring?
Consider your expertise, certifications, years of experience, and industry background — just like you would for an employee.
Action item: Keep a written summary of qualifications that support your compensation.
Location:
Where is your business operating?
Salaries vary by region. A reasonable salary in Los Angeles differs from one in rural Kansas. This ties into broader business valuation and routine business consultation planning.
Action item: Note cost-of-living considerations for your region in your file.
Balancing Salary With Cash Flow
While your salary must meet IRS standards, cash flow matters — especially for small business owners or new pass-through entities.
If your business is new or still stabilizing:
- You may start with a lower, but still reasonable salary, and adjust upward as profits grow.
- You can take owner distributions (after paying yourself the required S Corp salary) to access profits without increasing payroll taxes.
Just remember: salary comes first, then distributions.
Skipping salary entirely is one of the biggest S Corp tax pitfalls and a major red flag to the IRS.
Example: Finding a Reasonable Salary
Let’s say you run a small marketing agency that brings in $120,000 a year. You handle client accounts, invoicing, operations — essentially, you’re the business.
To determine a reasonable salary, you would evaluate all five IRS-recognized factors:
- Role & Duties: You perform client work, admin, and management — equal to a full-time employee.
- Industry Standards: Glassdoor/Indeed show marketing account managers in your area earning $55,000–$65,000.
- Business Size/Revenue: At $120,000 gross revenue, the business can support a moderate salary while retaining cash for expenses.
- Experience: Your 5–10 years of marketing experience justifies a salary in the mid-range of industry data.
- Location: Salaries in your region fall in the $55,000–$65,000 range.
Based on these combined factors, $55,000–$65,000 annually is a reasonable salary range.
You can then take remaining profits as shareholder distributions, which aren’t subject to payroll tax. This impacts Form 1040, Schedule K-1, your qualified business income (QBI deduction), and pass-through income.
Why It Matters
In the end, determining a reasonable S Corp salary comes down to staying aligned with IRS expectations, grounding your compensation in real-world data, and maintaining clear documentation to support your decisions.
By using industry benchmarks, evaluating your role and experience, and ensuring your business can sustain the amount you choose, you protect yourself from IRS scrutiny while optimizing tax savings such as payroll tax benefits. Proper recordkeeping also keeps your books clean for future loans, audits, or valuation needs and avoids the compliance issues often highlighted in federal reports and surveys.
With consistent W-2 withholding and organized financials, your annual tax filing becomes smoother—and you can run your S Corp with confidence knowing your compensation strategy is both compliant and financially sound.