You made the S-Corp switch. Now comes the question that trips up every owner: what salary actually goes on the paycheck?
Get this wrong two ways: too low and the IRS flags you. Too high and you kill the whole tax savings. Here’s how to land in the middle.
Why This Number Matters So Much
I’ve had clients come in with a $10K salary and $70K in distributions, thinking they’d found a loophole. They hadn’t — they’d found an audit. The entire tax benefit of an S-Corp comes from splitting income into salary and distributions, and the IRS knows it. "Reasonable salary" isn’t a suggestion — it’s the first thing they check.
What "Reasonable" Actually Means
Here’s the only test that matters: what would you actually have to pay someone to do your job? Not the minimum you can negotiate. What the market says your role is worth. That’s your floor.
Five Things Actually Move This Number
- Your role and duties — technical work, running the business, or both. Both count.
- Hours worked — full-time owner-operators generally can’t justify a part-time salary.
- Industry comparables — a marketing consultant and a general contractor have very different benchmarks.
- Company profitability — a great year doesn’t mean your salary spikes proportionally, but it should reflect real market value for the work.
- What you’d pay someone else — the clearest gut-check. If you’d pay $55K to replace yourself, that’s your floor.
One Myth to Skip
You’ll see online that "60/40 rule" — 60% salary, 40% distribution — as a safe default for S-Corps. Ignore it. There is no IRS formula. The IRS wants your salary to match your actual role, not a percentage of profit. A consultant doing $100K who pays themselves $60K is overpaying. A consultant doing $100K who pays themselves $20K is underpaying and setting themselves up for an audit. The only rule that matters is: market rate for your job.
A Real Example
Real example: bookkeeping practice, $90K net profit, full-time owner doing client work plus running the business. I see owners trying to justify a $20K salary here — that’s part-time assistant money, not full-time owner. They also try $85K — that kills the S-Corp benefit entirely.
The right number? $50K-$60K. That’s what a full-time bookkeeper/practice manager actually earns in that market. Leaves $30K-$40K as a distribution, still real savings, and the IRS won’t argue with it.
Here’s What Gets You Audited
- Salary under 30-40% of total profit with no clear justification
- Same salary year after year while distributions balloon — that’s a flashing light
- No paper trail showing how you landed on the number
- Paying yourself $0 or near-$0 salary while taking large distributions — the fastest way to get flagged
How to Actually Document This
Keep a file. Write down: comparable salaries for your role in your market, your hours, what you’d pay someone to replace you. One page. That’s it. When the IRS asks, you have an answer that isn’t ‘I guessed.’
Revisit It Every Year
And revisit it every year. Business grew 40% this year? Your salary should reflect that. Role changed? Number should move. Owners who lock in $50K year one and never adjust? They’re either overpaying or underpaying themselves for the next five years without knowing it.
Frequently Asked Questions
Q: What’s the IRS definition of "reasonable salary"?
A: The IRS doesn’t publish a formula. It’s what you’d actually have to pay someone else to do your job in your market. The test is market rate for your role, hours, and industry — not a percentage of profit.
Q: How often should I revisit my S-Corp salary?
A: Every year, minimum. If your business grew 50%, your salary should move. If your role changed, it should move. Locking in the same number year after year while distributions balloon is a red flag.
Q: What documentation do I need to justify my salary to the IRS?
A: A simple one-page file showing comparable salaries for your role in your market, your hours/responsibilities, and your reasoning. You don’t need formal documentation — just something that exists if they ask.
The Move
There’s no formula. It’s just market rate for your role, your hours, your industry. Get this wrong and you’re either throwing away tax savings or setting yourself up for an audit.
Let’s work out your number — book a call and we’ll land on a defensible salary that actually holds up.
