S Corp Owners Must Pay Reasonable Salary Before Distributions
Accounting expert David Riggs outlines IRS rules on S corp owner compensation, explaining how salary decisions affect payroll taxes and require documentation.
S corporation owners who also work in their businesses cannot simply take shareholder distributions as a way to sidestep payroll taxes, according to accounting expert David Riggs, who addressed the issue in a recent HelloNation feature. The IRS requires that working owners first receive what it considers reasonable compensation before any distributions are paid out.
Determining what qualifies as reasonable is not arbitrary. Riggs explained that factors including the owner's specific duties, relevant experience, hours worked, and compensation paid to comparable employees or contractors in similar roles all weigh into the analysis. Without a defensible rationale, owners risk IRS scrutiny and potential reclassification of distributions as wages — a costly outcome.
Read more How Comparative Market Analysis Shapes Home Listing Prices →
Documentation is central to the strategy's legitimacy. Riggs emphasized that salary decisions need supporting records, meaning owners should maintain written justification for the compensation level they set. That paper trail becomes critical if the IRS challenges the arrangement during an audit.
The stakes are significant because payroll taxes apply to wages but not to shareholder distributions. Some S corp owners have historically tried to minimize salary in favor of distributions to reduce their overall tax burden, but the IRS has actively pursued cases where compensation appeared artificially low relative to the services performed.
For small business owners structured as S corporations, getting the salary-versus-distribution balance right is one of the more consequential annual decisions they face. Continue reading at All Financial Services & Investing.
