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 with IRS payroll tax rules.
S corporation owners who draw income from their businesses cannot simply take shareholder distributions and skip payroll taxes — they must first pay themselves a reasonable salary, according to accounting expert David Riggs, writing in HelloNation.
The IRS requires working S corp owners to receive compensation that reflects the fair market value of the services they perform. Riggs explains that several factors inform what qualifies as reasonable, including the owner's specific duties, relevant experience, hours worked each week, and what comparable employees in similar roles earn in the open market.
Read more Required Minimum Distribution Rules Explained for Retirees →
The distinction between salary and distributions carries significant tax consequences. Salaries are subject to payroll taxes — Social Security and Medicare — while shareholder distributions are not. Because of that gap, the IRS scrutinizes S corps where owners take little or no salary but draw large distributions, treating the arrangement as an attempt to avoid employment taxes.
Riggs emphasizes that documentation is not optional. Business owners need supporting records that justify their chosen salary figure, including any analysis of comparable compensation data. Without that paper trail, owners risk IRS reclassification of distributions as wages, which can trigger back taxes, penalties, and interest.
For small business owners considering the S corp structure as a tax strategy, the takeaway is straightforward: the salary decision requires deliberate planning and ongoing recordkeeping, not a number picked arbitrarily at year-end. Continue reading at All Financial Services & Investing.
