S Corp Owners Must Set Reasonable Salary Before Taking Distributions
Accounting expert David Riggs outlines how S corp owners should structure compensation to stay compliant and minimize payroll tax exposure.
S corporation owners who draw money from their businesses face a critical tax requirement: 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 while distributions generally are not. The IRS scrutinizes compensation arrangements where owners take little or no salary and instead draw most of their income as distributions, a strategy that can reduce payroll tax liability but invites audit risk if the salary is not defensible.
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Riggs identifies several factors that determine what qualifies as reasonable compensation, including the owner's specific duties, professional experience, hours worked, and what comparable employees in similar roles earn in the open market. Each of these data points can serve as documentation if the IRS challenges the arrangement.
The underlying principle is that supporting records are not optional. Owners who cannot demonstrate how they arrived at a salary figure are exposed to reclassification of distributions as wages, which would trigger back payroll taxes, interest, and potential penalties. Maintaining a consistent paper trail — industry salary surveys, job descriptions, time logs — strengthens the owner's position significantly.
For small business owners weighing the S corp election as a tax-savings vehicle, the salary-versus-distribution balance is one of the most consequential compliance decisions they will make year over year. Continue reading at All Financial Services & Investing.
