S Corp Owners Must Set Reasonable Salaries Before Taking Distributions
Accounting expert David Riggs outlines IRS rules requiring S corp owners to pay themselves reasonable compensation before drawing shareholder distributions.
S corporation owners who also work in their businesses face a strict IRS requirement: they must pay themselves a reasonable salary before taking any shareholder distributions, according to accounting expert David Riggs, writing in HelloNation.
The distinction matters because salaries are subject to payroll taxes while distributions generally are not. Owners who underreport compensation and take most of their income as distributions risk IRS scrutiny, potential reclassification of payments, and back taxes with penalties.
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Riggs notes that determining what counts as reasonable compensation is not arbitrary. Factors such as the owner's specific job duties, relevant experience, hours worked, and pay rates for comparable positions in the same industry all inform a defensible salary figure. The IRS can challenge compensation it deems artificially low, making documentation essential.
Beyond arriving at a fair number, Riggs emphasizes that businesses must maintain supporting records that justify the salary chosen. A well-documented rationale — drawing on industry compensation data and the owner's actual role — provides a critical layer of protection during an audit and helps ensure the S corporation structure delivers its intended tax advantages without regulatory exposure.
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