How Much Should You Pay Yourself From Your S Corp?

Almost every article on this question warns you about one mistake.

Don't pay yourself too little.

Set the salary too low, and the IRS can reclassify your owner draws, with penalties and interest riding along.

That warning is real, and we'll cover it.

But it's only half the picture, and the half nobody talks about is costing owners money right now.

I've sat across the table from an owner paying himself $30,000 out of a business earning close to $900,000.

I've also sat across the table from an owner paying himself north of $300,000 who had no business paying himself that much.

Same question. Two owners. Opposite errors.

One of them was exposed.

The other was quietly overpaying payroll taxes every year and had no idea.

First, the Fast Version of Why Anyone Elects S Corp Status

If you're a sole proprietor, a single-member LLC, or an LLC or partnership shareholder, you're generally taxed the same way on this.

For every dollar of net profit in your company, 15.3% goes to self-employment tax.

That's 12.4 cents to Social Security and 2.9 cents to Medicare, leaving you 84.7 cents.

And that's before your income tax even enters the picture.

Follow the money on $500,000 gross, $300,000 expenses, $200,000 net profit.

As a sole proprietor, the self-employment tax alone is just north of $28,000.

As an S corporation with the same profit, you split it.

Take an $80,000 W-2 wage, pay FICA of a little over $12,000.

The remaining $120,000 comes as an owner distribution, generally exempt from Social Security and Medicare.

Savings in that illustration: just over $16,000 a year.

Two honest caveats on that table.

First, the illustration is actually a little bit flawed, because there's a cap on Social Security

wages, so once you're up at the $200,000 to $300,000 level the real number would be

somewhat less.

Second, and this one matters more for today: in no way, shape or form am I saying that $80,000 is a reasonable wage on $200,000 of net profit.

That number is for illustration purposes only.

We've written the deeper version elsewhere.

See The Hidden Tax of Being Your Own Boss for the mechanics, and When Should I Make The S-Corp Election For My LLC or C-Corp? for timing.

Why the Reasonable Compensation Requirement Exists

That $120,000 distribution is generally exempt from Social Security and Medicare.

So Uncle Sam says, hey, wait a second.

Those programs have to stay funded for the folks receiving them.

That's what generates the reasonable compensation requirement.

It isn't a trap and it isn't a punishment.

The requirement is written into the code to keep Social Security and Medicare funded.

Which means the number you put on your own W-2 is not a preference.

It's a position you have to be able to defend.

The Mistake Everyone Warns You About

Here's the classic example, and it's the one I lead with in our S Corp Basics video.

I had a case with an attorney. I'll call him Steve.

He was crushing it, making almost $900,000 a year, and paying himself about $30,000.

I told him, Steve, in what reality can you even hire a paralegal at 30 grand a year?

You can't.

That's not reasonable even for a paralegal.

For a full-fledged attorney who is the managing partner of the firm, that's not going to fly.

We raised his salary from about $30,000 to roughly $180,000.

Now here's the part most articles leave out.

He did not see much in the way of self-employment tax savings from that change.

He paid more in payroll taxes on his W-2 wage than he had been paying.

So what did he get?

A defensible position.

The win wasn't a smaller bill this year.

The win was that the structure he was already running finally held up.

The Mistake Nobody Warns You About

Now flip it.

In that same S Corp Basics video I walk through an owner-operator with a consulting company, about 20 employees.

He was paying himself as CEO, and he genuinely was the CEO.

That title was accurate.

But 20 employees is a certain kind of company.

He knew everybody's names.

He knew what their kids' names were.

In practice, he was more of an owner-operator than a true CEO.

He was paying himself north of $300,000 a year.

We dropped his wage to about $120,000, and that significantly saved him money on payroll taxes.

Nobody had ever told him his salary was too high.

The IRS is not in the business of calling to say you've been generous with yourself.

Every dollar he ran through W-2 wages instead of owner distributions carried payroll tax that a

distribution generally would not.

He'd done that year after year, on a number nobody had ever pressure-tested against what he actually did all day.

Too low creates exposure.

Too high just creates a bill you cheerfully pay and never question.

Both are the same underlying error: a salary that was picked instead of determined.

The Six Factors That Make a Salary Defensible

So what determines a reasonable, defensible salary?

Generally speaking, these six things.

Training and experience. What skill level does the role actually require?

Duties and responsibilities. What work is actually being performed by this individual?

Time devoted to the business. Are they a full-time operator or a part-time owner?

Comparable salaries. What would the market pay someone else to perform this role, or these roles, in your industry?

Business complexity. Revenue, staff, risk, and the decision-making load that sits on that person.

Compensation history. How has the pay changed as the company grew?

Run those six against both of the owners from our S Corp Basics video and you can see how both numbers came out wrong.

Steve's duties, complexity, and comparable market salaries were nowhere near $30,000.

The owner-operator's duties looked like a hands-on operator of a 20-person shop, not a $300,000 chief executive.

Neither of them was doing anything shady.

Neither of them had run the six factors.

We put the three methods we use to set the number, plus the documentation steps behind it,

into a free reasonable compensation training and playbook.

And because a defensible number is only as good as the records behind it, smart recordkeeping is the other half of the job.

S Corporations Are Built for Active Income

One more consideration, and it changes what should even be inside the S corp.

Generally speaking, S corporations are optimal for active income businesses.

They're a poor fit for income that is not active, things like rents, capital gains, and dividends.

In that same S Corp Basics video I mention a gentleman we're working with right now who owns a self-storage facility, about 300 units.

Rather than elect on the whole thing, we're keeping the property in the LLC and splitting the management activity away into an S corporation that will operate as a property management company.

He, his wife, and his two employees will manage the self-storage facility, plus his own properties and other people's properties as their real estate portfolio grows.

The rents stay where rents belong.

The active work of managing property, which is genuinely a job a person performs, moves into the entity where a reasonable wage makes sense.

Map that distinction before you elect anything.

It's exactly the kind of question choosing the right business entity is built to surface.

Should You Even Be an S Corp Yet?

Before you spend another minute on what to pay yourself, make sure the election belongs in your world at all.

Generally speaking, you're a good candidate when profits are consistently above the $70,000 to $80,000 mark.

That's the point where there's enough profit to pay yourself a reasonable salary.

You're an active owner with a clear role.

Your books are clean enough to show how profitable you actually are and where the money is going.

You're willing to run payroll for the owner, and you're ready for S corporation compliance.

A quick note on that payroll point, because owners get this backwards all the time.

You can absolutely be a sole proprietor or an LLC and run payroll for your employees.

But if you're an LLC or single-member LLC, you generally should not pay yourself as a W-2 employee.

The IRS wants you to take your income as an owner draw.

Skip the S corporation if your profits are low or inconsistent, or if you're posting losses.

There are basis limitations that come into play, and it's just not a good idea.

Same answer if the owner's role is unclear, or if you're mixing personal and business funds.

And then the question I ask every owner sitting on this decision.

Does the tax savings exceed the compliance costs?

You have to run payroll, and cover the administrative costs, legal compliance, and bookkeeping.

Clean books are load-bearing for all of it, which is why we call bookkeeping the magical ingredient in your tax savings.

If the election is already in place, S Corporations: How to Maximize Tax Savings covers the work that makes it pay off.

And if you're not the only owner, can the business sustain payroll for more than one of you, if more than one is actively engaged?

Where Our Lane Ends and an Attorney's Begins

We say this anytime anything in the legal sandbox comes up, and entity structure is squarely in that sandbox.

We're not attorneys at Make Taxes Fair, and we don't pretend to be.

Here's the distinction that matters.

Walk into an attorney's office and say "I want to be an S corp," and a good attorney will ask, "Great, do you want to be an LLC or a C corp first?"

A better attorney will ask you more questions about your business niche and what you do, to determine whether the state that you operate in requires you to be an LLC or a C corp for your

legal foundation.

Our aim here is a high level and general overview as it relates to taxes, with the goal of getting your world mapped clearly enough that you know which questions to go ask.

We always recommend consulting a qualified legal professional to make sure the pieces of the puzzle fit together the right way.

This Is the Legal Structure Pillar Doing Its Job

Reasonable compensation sits inside the Legal Structure pillar of our Make Taxes Fair CLEAR EDGE Framework.

Because Legal Structure shapes so much of how your business operates and is taxed, this pillar

is often one of the first things we hone in on with a new owner.

Getting Organized carries weight here too.

You cannot defend a number you cannot document.

Both of the owners from our S Corp Basics video were already paying themselves a W-2 wage.

Neither one had a defensible number, and neither one knew it.

The Happy Historian records what already happened, files the form, hands you the bill, and never tells you what was possible.

They'll process the $30,000 salary without a word about the exposure it creates, and process the $300,000 salary without ever asking whether the role justifies it.

Their job ended when the return was filed.

Yours never did.

That's exactly what our Tax Strategy Roadmap is built to catch.

We put your structure, your role, and your numbers on the table, run them through the CLEAR

EDGE pillars that apply to you, and tell you what your compensation position should be and why

it holds.

Friends don't let friends overpay the government.

The rest of our do-it-yourself Launchpad series lives inside our free tax strategy community at maketaxesfair.com/community 

Have questions? Let's start a conversation.