S Corp Owners Must Set Reasonable Salary Before Taking Distributions
Accounting expert David Riggs outlines why S corp owners must document reasonable compensation to avoid IRS scrutiny on payroll taxes.
S corporation owners who draw income from their businesses cannot simply take shareholder distributions without first establishing a reasonable salary, according to accounting expert David Riggs, writing in HelloNation. The distinction matters because salaries are subject to payroll taxes while distributions are not, making the compensation decision a frequent target of IRS review.
Riggs identifies several factors that determine what constitutes a defensible salary for a working S corp owner, including the nature of duties performed, relevant experience, hours devoted to the business, and what comparable employers would pay for similar work. Relying on any single benchmark is insufficient; the IRS expects a multi-factor analysis supported by documentation.
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The sequencing of compensation is equally important. An S corp owner must receive reasonable compensation before taking distributions — not after. Reversing that order, or skipping the salary step entirely to minimize payroll tax exposure, is a well-known audit trigger that can result in the IRS reclassifying distributions as wages, generating back taxes and penalties.
Proper recordkeeping underpins the entire strategy. Riggs emphasizes that salary decisions should be supported by written records that reflect how the compensation figure was reached. Without that paper trail, even a well-intentioned salary calculation is difficult to defend under examination. Business owners are advised to revisit their compensation structure annually as revenues and roles evolve.
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