Reasonable Salary (S-Corp)

Run an S-corp and you wear two hats: shareholder and employee. The IRS only cares about the employee one here. Before a dollar of profit reaches you as a distribution, the agency expects you to run a real W-2 paycheck through payroll for the work you actually do. That salary carries the 15.3% FICA load (12.4% Social Security up to the 2026 wage base of $184,500, plus 2.9% Medicare with no ceiling). Distributions skip all of it. That gap is the whole reason the S-corp election is worth the paperwork.

There's no formula in the code, which is exactly why owners get burned. The IRS weighs what you do, your training and experience, hours, what comparable people earn in your market, and how much of the profit is your sweat versus capital or staff. Pay yourself $35,000 on $300,000 of profit and you've painted a target on your return. When the IRS reclassifies a lowball salary, you don't just pay the back FICA, you pay both halves of it, interest, and an accuracy penalty that runs 20% (40% if it's substantial). The cheap salary stops being cheap.

A working benchmark is roughly 35% to 60% of net profit before owner pay, scaled to your industry and how hands-on you are. Treat that as a sanity check, not a safe harbor. A surgeon-owner whose revenue is all personal labor sits at the high end. A business carried by employees and equipment can defensibly sit lower. What protects you isn't the percentage, it's the file behind it: a comp study, BLS or industry wage data, your role description, the hours. Build that before you set the number, not after the audit letter shows up.

One wrinkle the OBBBA cemented in July 2025: the 20% qualified business income deduction is now permanent, and your W-2 salary does not count toward QBI. So every dollar you shift from distribution to salary trims your Section 199A deduction. The 2026 phase-out for joint filers runs $403,500 to $553,500. Above that range, in a specified service trade, the deduction can vanish entirely, which changes the math on how hard you push the salary down. This is where a low salary and a high salary both cost you, just in different columns.

So the real job is finding the floor the IRS will accept, then taking everything above it as distribution. Too low invites reclassification; too high hands back FICA and bites your QBI for no reason. Document the number, pay it on a real schedule through payroll, and keep the supporting data with your return. That's the difference between a strategy and a liability.