S Corp Owners Must Set Reasonable Salaries Before Taking Distributions

S corporation owners who draw income from their businesses face a specific tax obligation that can trip up the unwary: they must pay themselves a reasonable salary before taking any shareholder distributions, according to accounting expert David Riggs, writing in HelloNation.

The IRS scrutinizes how S corp owners divide their compensation between wages and distributions because only wages are subject to payroll taxes. Owners who shift too much income into distributions — and too little into salary — risk audits, back taxes, and penalties. Riggs emphasizes that the distinction is not merely a paperwork formality but a substantive compliance requirement with real financial consequences.

Read more Underinsured Motorist Coverage: What Drivers Need to Know →

Determining what counts as "reasonable" compensation is not arbitrary. Riggs points to several factors that should inform the calculation: the owner's specific job duties, relevant professional experience, the number of hours worked, and salary benchmarks for comparable positions in the same industry. Each of those elements should be documented, because supporting records are the primary defense if the IRS challenges a salary determination.

The timing and structure of distributions also matter. Shareholder distributions can only be taken after a reasonable salary has been established and paid, meaning owners cannot simply defer wages indefinitely to minimize their payroll tax burden. Tax advisers generally recommend that S corp owners review their compensation figures annually, particularly when business revenue or personal responsibilities change substantially.

For small-business owners weighing the S corp election as a tax-savings strategy, Riggs' guidance underscores that the structure's payroll-tax advantages come with compliance obligations that require active management and documentation. Continue reading at All Financial Services & Investing.