S corporation owner pay: what a reasonable salary means

The usual reason to elect S corporation status is payroll tax. An owner of an LLC taxed as a sole proprietorship or partnership pays self-employment tax, 15.3% up to the Social Security wage base, on nearly all of the profit. An S corporation owner pays Social Security and Medicare tax only on the salary the company pays them. Profit taken out as a distribution carries no payroll tax.

That gap is why the IRS watches the salary.

The rule

If you own an S corporation and work in it, the company must pay you reasonable compensation for that work, through payroll, before it pays you distributions. A company that pays its working owner $0 in salary and $120,000 in distributions is the pattern the IRS looks for, and it can recharacterize the distributions as wages, with back payroll tax, penalties and interest.

“Reasonable” means what the business would have to pay someone else to do the work you do.

How to set the number

The IRS lists factors courts have used. In practice we look at four:

1. What you do. List your roles and the share of your time each takes. An owner who spends 70% of the week cutting hair and 30% running the salon is mostly a stylist and partly a manager.
2. What those roles pay locally. Wage data for the Chicago metro area from the Bureau of Labor Statistics gives a defensible starting point for each role.
3. What the business can pay. Salary cannot exceed what the company earns. In a thin year a lower salary can be reasonable.
4. Your history. Experience, licenses and years in the trade push the figure up.

Write down how you got the number and keep the memo with the year’s records. If the salary is ever questioned, a dated note showing your method carries weight.

An example

Tom owns a two-van HVAC service company in Lisle as an S corporation. In 2026 the company expects $160,000 of profit before his pay. He runs service calls about 60% of the time and manages scheduling, quoting and the books the rest.

Local wage data puts an experienced HVAC technician around $75,000 a year and a small-company operations manager around $90,000. A weighted figure of about $81,000 is a reasonable salary. The remaining profit, less the company’s share of payroll tax on his salary, can go out as distributions.

Things owners miss

Run the salary through payroll, during the year. Salary means W-2 wages with withholding, paid through a payroll system. A single journal entry in December does not count. If you are behind, a few larger paychecks before December 31 still get the year right.

Health insurance goes on the W-2. If the company pays health insurance for an owner with more than 2%, the premiums are added to the owner’s W-2 wages in box 1. The owner can usually deduct them on Form 1040.

Illinois has its own tax on S corporations. Illinois charges S corporations a 1.5% personal property replacement income tax on their Illinois net income. It is a company-level tax on top of the owners’ income tax, so include it when you compare an S corporation with staying an LLC.

The election has a cost. You add payroll, quarterly payroll returns, a separate corporate return and its preparation fee. Below roughly $50,000 of profit, the savings often do not cover those costs.

When to revisit it

We review owner salary at the June and December planning meetings: in June so a change can run through the rest of the year’s payroll, in December to check that the year’s total matches the plan.