S Corp Owner Pay Rules: Salary vs. Distributions Explained
Accounting expert David Riggs breaks down how S corp owners must handle reasonable compensation before taking shareholder distributions.
S corporation owners who actively work in their businesses cannot simply take all profits as distributions — they must first pay themselves a reasonable salary subject to payroll taxes, according to accounting expert David Riggs, writing in HelloNation.
The distinction carries significant tax consequences. Salaries paid to owner-employees are subject to payroll taxes, while shareholder distributions are not. The IRS scrutinizes cases where working owners draw little or no salary but take large distributions, viewing the arrangement as an attempt to avoid payroll tax obligations.
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Determining what qualifies as reasonable compensation is not arbitrary. Riggs identifies several factors that inform the calculation, including the nature of the owner's duties, their level of experience, the number of hours worked, and comparable wages paid to non-owner employees performing similar work in the same industry.
Documentation is central to defending any salary decision. Riggs emphasizes that S corp owners need supporting records to justify their compensation figures — particularly in the event of an IRS audit. Without adequate records, owners risk having distributions reclassified as wages, triggering back payroll taxes, penalties, and interest.
The guidance underscores a broader compliance reality for small business owners who elect S corp status: the tax advantages of the structure depend heavily on getting compensation decisions right from the outset. Continue reading at All Financial Services & Investing.
