S Corp Owners Must Set Reasonable Salary Before Taking Distributions
Accounting expert David Riggs breaks down IRS rules on S corp owner pay, explaining how salary decisions affect payroll taxes and require documentation.
S corporation owners who draw compensation from their businesses face a specific IRS 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 of how payroll taxes apply differently to salary versus distributions. Salary payments are subject to Social Security and Medicare taxes, while distributions generally are not. The IRS scrutinizes S corp owners who attempt to minimize salary in favor of distributions as a way to reduce their overall payroll tax burden.
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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 or executives in similar roles would earn in the open market. These benchmarks help establish a defensible figure if the IRS questions the compensation structure.
Documentation is central to the expert's guidance. Owners who cannot support their salary decisions with clear records risk IRS reclassification of distributions as wages, which can trigger back taxes, penalties, and interest. Maintaining contemporaneous records of the rationale behind compensation decisions is considered essential practice for S corp owners.
The issue carries practical weight for small business owners who elect S corp status specifically for its tax advantages. Without a deliberate and well-supported compensation strategy, those advantages can erode quickly under an audit. Continue reading at All Financial Services & Investing.
