S Corp Owners Must Set Reasonable Salary Before Taking Distributions
Accounting expert David Riggs outlines how S corp owner compensation rules affect payroll taxes and why documentation is critical.
S corporation owners who draw income from their businesses face a specific tax obligation that cannot be sidestepped: they must pay themselves a reasonable salary before taking any shareholder distributions, according to accounting expert David Riggs, writing in HelloNation.
The IRS requires this because S corp distributions are not subject to payroll taxes, while wages are. Without a defensible salary on record, owner-operators risk having the agency reclassify distributions as wages, triggering back taxes, penalties, and interest. The distinction between the two forms of compensation is therefore more than a bookkeeping preference — it carries direct financial consequences.
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Riggs outlines several factors that inform what qualifies as reasonable compensation. These include the nature of the owner's duties, their level of experience and expertise, the number of hours worked, and what a comparable business would pay an outside hire performing the same role. No single formula applies universally, which makes the documentation process especially important.
Supporting records are central to surviving any IRS scrutiny. Owners who cannot demonstrate how they arrived at their salary figure leave themselves exposed in an audit. Riggs emphasizes that the process of setting compensation should be deliberate, repeatable, and backed by written analysis rather than chosen opportunistically to minimize tax liability.
For small business owners structured as S corporations, the takeaway is straightforward: compensation decisions require the same rigor applied to other financial planning. Continue reading at All Financial Services & Investing.
