How to set a reasonable salary for an S corp owner

An S corp owner who works in the business has to be on payroll. The IRS says it plainly on its page on S corporation compensation: "S corporations must pay reasonable compensation to a shareholder-employee" before taking distributions that are not wages.

This rule is where most of the S corp tax saving lives or dies. Salary carries Social Security and Medicare tax. Distributions do not. So the lower the salary, the bigger the saving, and the bigger the audit risk.

What the IRS actually says

There is no IRS formula and no percentage. The IRS fact sheet FS-2008-25 lists the factors courts have used when they decide whether a shareholder's pay was reasonable:

• Training and experience
• Duties and responsibilities
• Time and effort devoted to the business
• Dividend history
• Payments to non-shareholder employees
• Timing and manner of paying bonuses to key people
• What comparable businesses pay for similar services
• Compensation agreements
• The use of a formula to determine compensation

The IRS page on S corp compensation adds a second test. It looks at where the company's gross receipts come from: the shareholder's own services, the work of non-shareholder employees, or capital and equipment. Money earned by the owner's personal work should mostly flow out as wages. Money earned by staff or by equipment can more fairly come out as distributions.

A one-person consulting firm, where every dollar comes from the owner's hours, has a hard time defending a small salary. A shop with five employees and expensive machines has more room.

What a low salary costs if the IRS disagrees

The IRS can call your distributions what they really were: wages. Once it does, the company owes every employment tax it skipped, the employer's half and the employee's, with penalties and interest on top. In 2026 Social Security is 6.2% a side on wages up to $184,500. Medicare is 1.45% a side, uncapped.

Setting the salary at zero while taking out profit is the case the fact sheet was written about. Don't do that.

How owners set it in practice

The careful owners keep a short memo next to the payroll records saying how they got to the number. It usually goes something like this:

1. Write down your week. Selling, delivery, managing staff, admin: what do you really spend it on?
2. Price each job as if you were hiring for it. Wage surveys for your area and industry are the usual evidence.
3. Weight by hours. Say it's 30 hours a week of senior developer work and 10 of admin. Pay 30 hours at a developer's rate and 10 at an admin's.
4. Hold the result up against the business. You can't pay a salary bigger than the profit. Pay yourself a sliver of a profit your own work earned, though, and expect questions. Put the memo in the file and redo it every year, or sooner if the business changes.

Your accountant or payroll provider can help, and some sell reasonable compensation studies. A study is evidence. It is not a guarantee.

The StructureCost default

Leave the salary field blank and the calculator assumes 40% of profit, but never less than $30,000. On a small profit that floor bends, so the salary never ends up above profit.

The rule is only there to give the comparison a number. You won't find 40% anywhere in IRS guidance. The $30,000 floor isn't an IRS threshold either; it's a rough guess at a modest full-time wage. Picture a dentist clearing $400,000, all of it from hours in their own chair. Their salary may have to sit much closer to an employed dentist's pay. Compare a software reseller whose staff do the work, who may be able to justify less.

Start from the default, then. Once you've worked out your own figure, type it in and see what happens to the S corp result.

Worked example: what the salary choice changes

Say you own a single-member LLC taxed as an S corp, and in 2026 it makes $100,000 before you pay yourself anything.

Rates are from Topic 751. The employer pays 6.2% plus 1.45%, and the employee pays the same. Going from $40,000 to $60,000 of salary adds $3,060 of payroll tax. Some of that you get back, since the employer half is a business expense and trims your income tax a little.

The QBI deduction moves too. Section 199A(c)(4) keeps salary paid to the owner out of qualified business income, so every extra dollar of salary is a dollar less profit for the deduction to work on. Cut the salary and the deduction grows. Change the salary in the calculator and it works out both effects for you.

Health insurance and the salary

Own more than 2% of the shares and have the S corp pay your health insurance? The premiums go into your W-2 wages, Box 1. They don't carry Social Security, Medicare or FUTA tax, per the IRS fact sheet. Get payroll to set them up that way: wages for income tax, outside the payroll tax base.