What is a Reasonable Salary for an S Corporation Officer?

corporate officers
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The S Corporation Owner/Employee and Income Taxes

S corporation owners (actually, shareholders) are in a unique situation when it comes to income taxes. The S corporation, unlike a corporation, passes through the taxes of the business to the owners, while a C corporation pays its own taxes. 

S corporation shareholders don't pay self-employment taxes (Social Security and Medicare) on their distribution from the business.

But S corp owners who work as employees must be paid a "reasonable" salary," before their share of the profits. 

Let's look at an example: 

Carol and John are 50/50 shareholders in an S Corp and they both work in the business. Their net profit last year was $250,000. They would like to split the profits and take them as a distribution, to avoid self-employment tax, but since they work in the corporation, they must first take a "reasonable" salary. 

How S Corporation Owners Try to Avoid Taxes

Some S corporation shareholders who are officers of the company attempt to avoid paying employment taxes by minimizing the salaries and bonuses they pay to corporate officers and instead considering payments as loan payments or payments of personal expenses.. 

What the IRS Says About S Corporation Employees

The IRS states specifically that corporate officers are employees and that companies must comply with all employment laws in relation to these employees, including:

The IRS notes in its August 2008 article Wage Compensation for S Corporation Officers,

"The fact that an officer is also a shareholder does not change the requirement that payments to the corporate officer be treated as wages."

What is a reasonable salary for an S Corp Owner/Employee? 

To find a reasonable salary for an S corporation owner/employee, consider how you would find a reasonable salary amount for any new employee. The IRS guidelines suggest you look at the following factors to determine "reasonable" salaries for your corporate officers:

  • 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

Using Comparable Salaries to Back Up Your Salary Figures

Another way to determine a reasonable salary for corporate officers is to look at what other companies of similar size and type pay for such services. Check on websites like The Ladders and Salary.com for comparable positions, or engage the services of a compensation consultant.

Your ability to substantiate the salaries you are paying to top executives and corporate officers will help keep you on the right side of the IRS when it comes time for them to review your company's tax returns.

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