What's a "Reasonable Salary" for S Corp Owners? (And Why It Matters to the IRS)

Electing S Corp status can help small business owners legally reduce self-employment taxes, but there’s one key requirement that can make or break this strategy: paying yourself a reasonable salary.

If you underpay yourself in hopes of maximizing tax-free distributions, the IRS may reclassify those distributions as wages and hit you with back taxes, penalties, and interest. On the flip side, if you overpay yourself, you’ll miss out on the very tax benefits that make the S Corp structure so powerful.

So how do you determine what “reasonable” means — and how can you stay compliant without leaving money on the table?

Why the IRS Cares About Your Salary

S Corporations avoid self-employment taxes on distributions, but salaries are still subject to payroll taxes. The IRS is fully aware of this advantage and watches for abuse. Their position is clear: if you perform work for your business, you must be compensated with a reasonable salary before taking distributions.

Failing to do so can trigger an IRS audit. If the IRS decides your salary is unreasonably low, they can reclassify distributions as wages, assess back payroll taxes, and even impose penalties.

What Counts as a “Reasonable” Salary?

The IRS provides limited guidance on how to determine a reasonable salary. Here are key factors to consider:

• Industry standards for similar roles

• Duties performed (executive leadership, sales, admin, etc.)

• Time spent working in the business

• Experience and education

• Company profits and revenue

You don’t need to be exact, but your salary should reflect what you’d pay someone else to do your job if you were hiring. If you wear many hats — CEO, marketer, accountant — your compensation should reflect that.

Tools and Strategies to Set Your Salary

There are multiple ways to estimate your salary and support it in case of an IRS inquiry:

1. Market data: Use platforms like Glassdoor, Payscale, or the Bureau of Labor Statistics to find average salaries in your field.

2. Job boards: Search roles similar to yours in your region.

3. Split approach: Start with a 60/40 or 50/50 split (salary/distributions) as a rule of thumb, adjusting based on risk tolerance and business profitability.

4. Third-party reports: If you’re earning over $250K, consider hiring a valuation firm to provide a compensation analysis. This shows good faith in case of audit.

Real-World Example

Samantha runs a marketing consulting firm that brings in $180,000 in net profit. She elects S Corp status and pays herself a salary of $90,000. The remaining $90,000 is taken as a distribution.

• Her $90,000 salary is subject to payroll taxes.

• Her $90,000 distribution avoids the 15.3% self-employment tax — saving her roughly $13,770.

Because $90,000 is in line with market rates for marketing consultants in her area, Samantha is well-positioned to defend her salary choice.

When to Re-Evaluate Your Salary

As your business grows, your salary should be reviewed and adjusted. A $50,000 salary might be appropriate in year one, but not in year three when you’re netting $300,000. Regular review shows the IRS that you’re being proactive and fair.

Also, if your role changes — for example, you hire employees and step into a more strategic position — your salary may need to shift accordingly.

Final Thoughts

“Reasonable salary” isn’t a fixed number, but it’s a critical compliance measure. Done right, it allows you to enjoy the benefits of the S Corp structure without IRS headaches. Done wrong, and you risk undoing all your tax savings.

If you’re not sure what salary makes sense for your business, it’s best to work with a tax advisor. A small investment in planning can save you big when it comes to taxes — and peace of mind.

Have questions about how much you should be paying yourself as an S Corp owner? Book a free strategy call and get clarity on how to maximize your savings the right way.

Haven't grabbed your free guide yet? Download the 7 Tax Strategies Every 6-Figure Earner Should Know to uncover powerful tax-saving insights.