S Corp Owners Must Pay Reasonable Salary Before Taking Distributions
Accounting expert David Riggs outlines IRS rules requiring S corp owners to draw a reasonable salary before shareholder distributions to avoid payroll tax penalties.
S corporation owners who skip a reasonable salary before taking shareholder distributions risk significant IRS scrutiny, according to accounting expert David Riggs, who addressed the issue in a recent HelloNation feature. The distinction matters because distributions are not subject to payroll taxes, while wages are — creating an incentive for some owners to minimize salary in favor of distributions.
Riggs emphasizes that the IRS requires working S corp owners to compensate themselves in a manner consistent with what an outside employer would pay for similar duties. Factors used to determine a defensible salary figure include the owner's specific job duties, professional experience, hours worked, and comparable compensation benchmarks within the relevant industry.
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Documentation is central to the guidance Riggs provides. Salary decisions supported by written records — such as job descriptions, industry wage surveys, and board minutes — are far more defensible during an audit than figures chosen without supporting rationale. The IRS has repeatedly challenged arrangements where owner-employees drew little or no wages while pulling substantial distributions from profitable S corporations.
The underlying tax mechanics are straightforward: wages are subject to Social Security and Medicare taxes, while properly classified shareholder distributions are not. That gap makes reasonable compensation one of the most scrutinized areas of small-business taxation, and errors can result in back payroll taxes, interest, and penalties.
For S corp owners navigating compensation decisions, Riggs' advice underscores the importance of working with a qualified tax professional to establish and document salary levels annually rather than treating the figure as a one-time decision. Continue reading at All Financial Services & Investing.
