S Corp Owners Must Balance Salary and Distributions Carefully
Accounting expert David Riggs outlines why S corp owners need defensible salary records before taking shareholder distributions.
S corporation owners who also work in their businesses face a specific tax obligation that catches many off guard: they must pay themselves a reasonable salary before drawing shareholder distributions, according to accounting expert David Riggs, writing in HelloNation.
The distinction carries real financial consequences. Salaries paid to owner-employees are subject to payroll taxes, while distributions generally are not. Because of that gap, the IRS scrutinizes cases where working owners take little or no salary and instead pull most of their compensation through distributions, a strategy that can trigger back taxes, penalties, and interest.
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Riggs emphasizes that determining what counts as "reasonable" is not arbitrary. Factors that inform the calculation include the owner's specific duties within the company, relevant experience and qualifications, the number of hours worked, and what comparable businesses pay for similar roles. Each of those factors should be documented so the compensation decision can withstand IRS review.
The supporting records piece is critical. Without documentation, even a salary set at a defensible dollar amount can be difficult to defend in an audit. Riggs advises that owners treat their compensation decisions the same way any arm's-length employer would — with written justification tied to market data and job responsibilities.
For small-business owners weighing S corp election as a tax strategy, the reasonable salary requirement represents one of the most important compliance obligations to understand before structuring their compensation. Continue reading at All Financial Services & Investing.
