S Corp Owners Must Set Reasonable Salary Before Taking Distributions
Accounting expert David Riggs outlines how S corp owners must document reasonable compensation to stay compliant with IRS payroll tax rules.
S corporation owners who draw income from their businesses cannot simply take shareholder distributions without first paying themselves a reasonable salary, according to accounting expert David Riggs, writing in HelloNation. The distinction carries significant consequences for payroll taxes, making the compensation decision one of the most scrutinized areas of S corp ownership.
Riggs identifies several factors the IRS and courts weigh when evaluating whether a salary is reasonable: the owner's specific duties within the company, relevant experience and qualifications, hours worked, and compensation paid to comparable employees or executives in similar industries. Together, these elements form the analytical framework an owner should use before setting a figure.
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The guidance underscores that documentation is not optional. Owners who cannot produce supporting records for their salary decisions face heightened audit risk, particularly if distributions significantly outpace wages. The IRS has long viewed lopsided compensation structures — low salaries paired with high distributions — as a mechanism to avoid payroll taxes, and it pursues reclassification aggressively.
For small business owners weighing the S corp structure, the takeaway is that the tax advantages of passing income through as distributions come with a non-negotiable condition: compensation must be set thoughtfully, benchmarked against market data, and backed by contemporaneous records. Failing that standard can trigger back taxes, penalties, and interest that erode the very savings the structure was designed to create.
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