By If you own an S corporation and work in the business, the IRS expects you to pay yourself a reasonable salary before taking the rest of your profits as distributions.
With wages subject to a combined 15.3 percent payroll tax up to the $184,500 Social Security wage base in 2026, it is tempting to keep that salary low or skip it entirely. That strategy carries real risk.
When the IRS finds a salary too low, it can recharacterize your distributions as wages and collect the payroll taxes your S corporation should have paid, plus interest and penalties.
The IRS takes this issue seriously enough to pursue return preparers too. In one case reported by tax attorney Eric L. Green, the IRS assessed a CPA $130,000 in preparer penalties because 13 of his S corporation clients took little or no salary, even though he had urged the clients for years to pay themselves properly.
In that audit, the IRS agent repeatedly asked for a written report justifying the salary. That report is your best protection too. We recommend that you do the following:
- Set your salary before year-end, based on the work you actually perform.
- Obtain a written reasonable compensation report that documents how you arrived at the figure.
- Keep the report with your corporate records.
This report does not guarantee a win, but it answers the first question an auditor will ask: Where’s the evidence?
If you want to discuss reasonable compensation, please call me on my direct line at 408-778-9651.