Key Takeaways
- Reasonable salary must be “reasonable for the services performed,” not a specific percentage
- IRS looks at industry comparables, time worked, experience, and business profitability
- Too-low salary risks IRS reclassification (distribution → wages) plus penalties
- Too-high salary wastes money on unnecessary payroll taxes
- QBI deduction adds complexity: sometimes higher salary increases your total deduction
- The 2026 Social Security wage base is $176,100
The S-Corp reasonable salary question is the most common planning challenge S-Corp owners face. Pay yourself too little, and the IRS may reclassify your distributions as wages, hitting you with back taxes and penalties. Pay yourself too much, and you’re wasting money on unnecessary payroll taxes.
There’s no magic percentage or calculator that gives you the “right” answer. Reasonable compensation depends on your specific facts: your role, your industry, your experience, and your business’s financial situation.
This guide explains how the IRS evaluates reasonable salary, how to determine yours, and how the QBI deduction complicates the decision in 2026.
What Is Reasonable Compensation?
The IRS defines reasonable compensation as the amount that would ordinarily be paid for similar services by similar businesses under similar circumstances. It’s what you would pay an unrelated employee to do your job.
Key points:
- Not a formula: There’s no IRS-approved percentage or calculation
- Case-by-case determination: Based on facts and circumstances
- Service-based: Compensation must be reasonable for the services performed, not for your ownership stake
Why it matters: S-Corps require owners who work in the business to take reasonable salary. You can’t pay yourself $10,000 and take $200,000 in distributions just because it saves taxes. The IRS will notice.
For IRS requirements in detail, see our guide on determining S-Corp compensation IRS requirements.
Why S-Corp Salary Matters
Getting your S-Corp salary right has significant financial implications.
The Tax Savings of S-Corps
The S-Corp structure saves taxes through the salary/distribution split:
- Salary: Subject to FICA taxes (15.3% total: 12.4% Social Security up to wage base + 2.9% Medicare)
- Distributions: Not subject to self-employment or FICA tax
Example: $200,000 Net Business Income
| All Salary | $80K Salary + $120K Distribution |
|---|---|
| FICA on $200K: $17,074 | FICA on $80K: $12,240 |
| Savings: $4,834 |
On higher incomes, savings grow substantially. A business owner with $400,000 net income might save $15,000-$25,000 annually through proper S-Corp structuring.
The IRS Risk of Too-Low Salary
The IRS actively pursues S-Corp owners who underpay themselves. When they win:
Consequences include:
- Distributions reclassified as wages
- Back employment taxes (both employer and employee portions)
- Interest on unpaid taxes
- Accuracy-related penalties (20-40%)
- Trust fund recovery penalty risk (100% personal liability for the “employee” portion)
Famous Cases:
- Watson v. Commissioner: CPA paid himself $24,000 while taking $200,000+ in distributions. Tax Court ruled salary was unreasonable. IRS won.
- Radtke v. United States: Attorney paid himself $0 salary. Court ruled he owed employment taxes on all distributions.
These cases establish that working S-Corp owners must take reasonable salary regardless of how they prefer to structure compensation.
The Cost of Too-High Salary
Overpaying yourself wastes money:
- Unnecessary FICA taxes that could have stayed in your pocket
- Can’t undo extra payroll taxes once paid
- Reduces distributions available for QBI planning (W-2 wages reduce QBI)
The goal is the Goldilocks zone: not too high, not too low.
IRS Factors for Reasonable Salary
The IRS and courts consider multiple factors when evaluating reasonable compensation. No single factor is determinative; it’s the totality of circumstances.
Factor 1: Training and Experience
Your background affects what’s reasonable:
- Education level (degree, certifications)
- Years in the industry
- Specialized skills or certifications
- Professional licenses
A physician with 20 years of experience commands higher compensation than a first-year freelancer.
Factor 2: Duties and Responsibilities
What do you actually do?
- Day-to-day activities
- Decision-making authority
- Management responsibilities
- Client relationship management
- Strategic planning
Document your role thoroughly. If you’re the CEO, CFO, and lead consultant rolled into one, your compensation should reflect all those responsibilities.
Factor 3: Time Devoted
How many hours do you work?
- Full-time vs. part-time involvement
- Weekly hours committed
- Seasonal variations
A business owner working 60 hours weekly justifies higher salary than one working 20 hours.
Factor 4: Comparable Salaries
What would you pay someone else to do your job?
Research sources:
- Bureau of Labor Statistics — Occupation-specific wage data
- Salary.com, Glassdoor, PayScale — Industry comparables
- Industry associations — Specialized salary surveys
- Geographic adjustments — San Francisco vs. Des Moines
Factor 5: Business Profitability
The business’s financial health matters:
- Gross and net revenues
- Historical profitability trends
- Industry average margins
- Owner’s direct contribution to profits
A profitable business can support higher owner compensation than one struggling to break even.
Factor 6: Dividend History
Pattern of distributions over time:
- Salary-to-distribution ratio historically
- Reasonable return on shareholder investment
- Consistency of distributions
Courts look suspiciously at S-Corps that suddenly start paying minimal salary when profits increase.
How to Determine Your Reasonable Salary
A defensible reasonable salary determination follows a structured process.
Step 1: Document Your Role
Create a detailed job description:
- List every significant duty you perform
- Estimate time spent on each category
- Note decision-making authority
- Document skills and credentials required
This isn’t just for the IRS. It helps you understand what your role is actually worth.
Step 2: Research Comparables
Find what similar positions pay:
Bureau of Labor Statistics (bls.gov):
- Search by occupation
- Filter by geography
- Note the mean, median, and percentile data
Commercial Sources:
- Salary.com salary reports
- Glassdoor company data
- PayScale industry surveys
Industry-Specific:
- Trade association salary surveys
- Professional organization data
Document your sources. Keep copies of salary data you relied upon.
Step 3: Consider Business Factors
Adjust for your specific situation:
- Is your business more or less profitable than industry average?
- How directly do you drive revenue?
- How long has the business existed?
- What’s the growth trajectory?
A consulting firm owner generating $500,000 in revenue as the sole rainmaker justifies higher salary than one generating $150,000.
Step 4: Factor in QBI
The QBI deduction complicates reasonable salary in 2026.
If income is below QBI threshold ($203K single / $406K MFJ):
- Salary decision: Minimize within reasonable range
- Lower salary = less FICA = more cash in pocket
- QBI deduction isn’t limited by wages
If income is above QBI threshold:
- QBI limited to 50% of W-2 wages (or 25% + property test)
- Higher salary = higher wage limitation = potentially higher QBI deduction
- Must balance: FICA cost vs. QBI benefit
Example calculation:
Business owner with $400,000 QBI, above threshold:
| Salary | FICA Cost | QBI Limitation (50% wages) | QBI Deduction | Tax Savings from QBI |
|---|---|---|---|---|
| $60K | $9,180 | $30,000 | $30,000 | ~$9,900 (33% rate) |
| $120K | $16,074 | $60,000 | $60,000 | ~$19,800 |
Extra $60K salary costs ~$6,900 more FICA but generates ~$9,900 more QBI savings. Net benefit: ~$3,000.
Use our QBI calculator to model your specific situation.
Step 5: Document Your Reasoning
Keep written documentation of:
- Job description and duties
- Time commitment
- Comparable salary research (with sources)
- Calculation methodology
- Business factors considered
- Annual review notes
Update annually. Reasonable salary should be reviewed each year, especially when:
- Your role changes significantly
- Profitability changes substantially
- You learn of new comparable data
- IRS issues updated guidance
Board resolution (recommended): For added protection, have the S-Corp’s board of directors formally approve the salary. Document the reasoning in meeting minutes.
The QBI and Reasonable Salary Interaction
The QBI deduction (Section 199A) adds a strategic dimension to reasonable salary decisions.
Below QBI Threshold
If your taxable income is below $203,000 (single) or $406,000 (MFJ):
- QBI deduction: Full 20% on qualified business income, no wage limitation
- Salary strategy: Minimize FICA by keeping salary at the low end of reasonable
- Net effect: Lower salary = less FICA = more money in pocket
The QBI deduction is available regardless of how much W-2 wages you pay yourself.
Above QBI Threshold (Wage Limitation)
If your taxable income exceeds $203,000 (single) or $406,000 (MFJ):
- QBI deduction: Limited to 50% of W-2 wages (or 25% wages + 2.5% property)
- Salary impact: Higher salary = higher wage limitation = potentially higher QBI deduction
- Trade-off: More FICA taxes but higher QBI deduction
The math:
QBI deduction is worth 20% of qualified business income, multiplied by your marginal tax rate. For someone in the 35% bracket, every dollar of additional QBI deduction saves $0.35 in taxes.
FICA costs 15.3% (up to the Social Security wage base) or 2.9% (above it).
Above the wage base ($176,100 for 2026), additional salary only costs 2.9% Medicare tax but can generate QBI deduction worth 7%+ of deduction value. That’s often a good trade.
Example:
- Current salary: $100,000
- Considering increase to: $150,000
- Additional FICA: ~$5,733 (on $50K above wage base: only Medicare)
- Additional QBI limitation: $25,000 (50% of $50K)
- Tax value of $25K more deduction at 35%: $8,750
- Net benefit: $3,017
2026 Payroll Tax Numbers
Current figures for planning:
| Tax | Rate | Notes |
|---|---|---|
| Social Security | 12.4% total | Split 6.2% employer / 6.2% employee |
| Social Security Wage Base | $176,100 | SS tax only on wages up to this amount |
| Medicare | 2.9% total | Split 1.45% employer / 1.45% employee |
| Medicare Wage Base | None | No cap on Medicare wages |
| Additional Medicare Tax | 0.9% | Employee only, on wages over $200K |
| Total FICA | 15.3% | On first $176,100 |
| FICA Above Wage Base | 2.9% | Medicare only above $176,100 |
Common Reasonable Salary Approaches
Different methods can support your salary determination.
Approach 1: Industry Comparable Method
How it works: Research what employees in similar positions at similar companies earn. Adjust for geography, experience, and company size.
Advantages:
- Most defensible with IRS
- Objective data sources
- Well-documented methodology
Best for:
- Most S-Corp owners
- Clear job roles
- Industries with good salary data
Approach 2: Time-Based Allocation
How it works: Calculate an hourly rate for an equivalent employee. Multiply by hours worked.
Example: Comparable hourly rate for marketing consultant: $75/hour Hours worked: 2,000/year Reasonable salary: $150,000
Advantages:
- Clear connection to time invested
- Works well for part-time involvement
- Easy to document
Best for:
- S-Corp owners with clear time records
- Part-time business operators
- Multiple-business owners
Approach 3: Revenue Split Method
How it works: Allocate a portion of revenue to owner services based on contribution.
Example: Total revenue: $500,000 Owner directly generates 60% of revenue Reasonable salary: $300,000 × comparable rate adjustment
Disadvantages:
- Less common
- Harder to defend
- Better as supporting analysis, not primary method
What Doesn’t Work
“Zero salary because the company is losing money”: Courts rarely accept this. You’re providing services with value regardless of profitability. A minimal reasonable salary is usually required.
“10% of revenue”: No basis for this as a method. It’s just an arbitrary percentage.
“Minimum wage”: Unless you truly work minimal hours in a limited role, this won’t hold up.
“Whatever’s left after distributions”: This is backwards. Salary comes first, then distributions from remaining profit.
Documentation and Audit Protection
Good documentation is your best defense if the IRS questions your salary.
What to Document
- Job description: Detailed duties and responsibilities
- Time records: Hours worked (estimates are acceptable if reasonable)
- Comparable research: Print salary data with sources and dates
- Calculation methodology: How you arrived at the number
- Business financials: Profitability context
- Annual review notes: What changed year over year
When to Update
- Annually: Before year-end payroll decisions
- Role changes: When responsibilities increase or decrease significantly
- Profitability changes: When business income changes substantially
- New guidance: When IRS issues relevant guidance or court decisions
Corporate Formalities
Board resolution: Have the board of directors formally set and approve compensation. Document in meeting minutes.
Employment agreement (optional but helpful): A written employment agreement between you and the S-Corp adds formality.
Payroll records: Maintain complete records of all payroll runs, tax deposits, and W-2s.
Examples by Industry and Income
Here are illustrative salary ranges by industry. These are starting points, not prescriptions. Your actual reasonable salary depends on your specific facts.
| Industry | Net Income | Typical Salary Range | Notes |
|---|---|---|---|
| Consulting | $250,000 | $90,000-$140,000 | Time-intensive, expertise-based |
| Real Estate Agent | $300,000 | $80,000-$120,000 | Commission-based, market varies |
| E-commerce | $200,000 | $60,000-$100,000 | Less time-intensive if automated |
| Medical Practice | $500,000 | $200,000-$350,000 | Professional standards apply |
| IT Services | $350,000 | $100,000-$160,000 | Technical expertise valued |
| Marketing Agency | $400,000 | $120,000-$180,000 | Client-facing, management role |
| Construction | $300,000 | $80,000-$130,000 | Varies by role (office vs. field) |
| Legal Services | $400,000 | $150,000-$250,000 | Professional standards, market rates |
Note: These ranges are illustrative. Actual reasonable salary depends on specific facts and circumstances including geography, experience, time devoted, and business profitability.
Frequently Asked Questions
What percentage of S-Corp income should be salary?
There’s no magic percentage. The IRS looks at whether salary is reasonable for the services performed, not whether it’s a certain percentage of profit. Typical ranges fall between 30-70% depending on the business, the owner’s role, and income level. The right percentage for you depends on your specific facts.
Can I pay myself $0 salary if my S-Corp loses money?
Generally no, if you’re working in the business. You’re providing services that have value regardless of profitability. Courts have consistently ruled that working S-Corp owners must take reasonable salary. A minimal reasonable salary is usually required, though it may be lower during genuine hardship.
What happens if the IRS says my salary is too low?
The IRS can reclassify distributions as wages. You’ll owe back payroll taxes (both employer and employee portions), interest on the unpaid amount, and potentially accuracy-related penalties (20-40%). In serious cases, the trust fund recovery penalty may apply, making you personally liable for the employee portion.
How does reasonable salary affect my QBI deduction?
If you’re above the QBI income threshold ($203,000 single / $406,000 MFJ for 2026), your QBI deduction may be limited by W-2 wages. Higher salary can actually increase your QBI deduction by raising the wage limitation, which may offset the extra FICA cost.
Should I use a reasonable compensation study?
For complex situations or high incomes ($300,000+), a formal compensation study provides strong audit protection. The study is conducted by a third-party expert who documents comparable analysis. For most small S-Corps, documented comparable research using BLS data and salary surveys is sufficient.
How often should I review my S-Corp salary?
At minimum, annually before year-end payroll decisions. Also review when your role changes significantly, when profitability changes substantially, or when you’re doing year-end tax planning. The salary that was reasonable at $200,000 income may not be reasonable at $400,000.
Get Your Salary Right
The reasonable salary determination affects everything else in S-Corp tax planning. Get it wrong, and you’re either overpaying taxes or inviting IRS trouble.
At SDO CPA, we analyze S-Corp salaries against industry benchmarks, your specific role, and QBI optimization opportunities. We balance FICA savings with QBI planning to find the true optimal point.
What a Salary Analysis Includes:
- Role documentation — Capturing your actual duties and time
- Comparable research — Industry-specific salary data
- QBI modeling — Threshold analysis and optimization
- FICA vs. QBI trade-off — Finding the real optimal salary
- Documentation package — Audit-ready support for your salary
Ready to get your S-Corp salary right? Schedule your S-Corp salary review with SDO CPA.