How Much Salary Should You Pay Yourself From Your S Corporation?

Enough to be reasonable compensation for the work you do, and the IRS expects that salary to come before any non-wage distributions (IRS). There is no official percentage. The number should reflect your role, your hours and what similar businesses pay someone to do that job.

Owners usually choose an S corporation for one reason: profit paid out as distributions instead of wages generally avoids payroll taxes. That benefit only holds up if the salary is defensible. With year-end payroll a few weeks away, now is the time to check yours.

This is general education, not advice for your specific situation.

What does the IRS mean by reasonable compensation?

The IRS's rule is short: an S corporation must pay a shareholder-employee reasonable compensation for services "before non-wage distributions may be made" to that owner. The IRS also says it has authority to reclassify distributions as wages, and that several court cases support it (IRS).

The Form 1120-S instructions make the same point: distributions and other payments to a corporate officer "must be treated as wages to the extent the amounts are reasonable compensation for services rendered" (IRS Form 1120-S instructions).

Reasonable doesn't mean the most you can justify. It means what the business would pay someone else to do your job.

What factors does the IRS use to judge your salary?

The IRS lists the factors courts have used (IRS):

• 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

In practice, the strongest support is usually a written record. That means what you do, how many hours you work, and salary data for comparable roles in your market. If you wear several hats, such as CEO, lead salesperson and lead engineer, it can help to think about what each role would cost to hire.

How much payroll tax is really at stake?

Here are the 2026 numbers that drive the decision:

• Social Security: 6.2% from the employer and 6.2% from the employee on wages up to $184,500 (IRS Topic 751).
• Medicare: 1.45% each on all wages, plus a 0.9% Additional Medicare Tax withheld on wages over $200,000 (IRS Topic 751).
• 2027 wage base: Social Security has announced it will rise to $192,300 (SSA).

Here's a hypothetical comparison for an owner whose S corporation earns $250,000 before owner pay. It shows combined employer and employee Social Security and Medicare tax only. It ignores the QBI deduction, retirement contributions, unemployment tax and the Additional Medicare Tax.

The $60,000 difference in salary costs about $9,180 in payroll taxes. That gap is why low salaries are tempting, and why the IRS looks at them. Whether $90,000 or $150,000 is reasonable depends on the work, not on the tax savings.

Why isn't the lowest defensible salary always best?

A smaller salary saves payroll tax today, but it has trade-offs:

• Social Security benefits: only wages count toward your earnings record. Distributions don't.
• Retirement savings: contributions to a company 401(k) are tied to your W-2 compensation, so a lower salary can cap what you can put away.
• The QBI deduction: reasonable compensation you receive isn't qualified business income. At higher incomes, though, the deduction can be limited by the W-2 wages the business pays, and your salary counts toward those wages (IRS). A salary that's too low can shrink the deduction.
• Audit exposure: if the IRS reclassifies distributions as wages, you owe the payroll taxes, plus possible penalties and interest.

The right number balances all four. That's usually a calculation worth running, not a guess.

When should you revisit your S corp salary?

Reasonable compensation isn't a number you set once. The IRS factors are about your duties, time and comparable pay, and those change as the business does. I'd review the salary at least once a year, and sooner when:

• Profit changes sharply. A strong year with an unchanged salary pushes more income into distributions and invites the question of whether the pay still fits the work.
• Your role changes. If you hire a manager and step back, or take over sales after someone leaves, your duties and hours have changed.
• You add a co-owner or key employee. What the business pays non-owner employees is one of the IRS factors, so a new hire's pay becomes a reference point for yours.
• You're planning a sale or succession. Buyers and their advisors review payroll history, and a well-documented owner salary makes the business's earnings easier to understand.
• Your retirement plan changes. A new 401(k) or a change in contribution goals may justify a different salary.

A short annual memo, kept with your corporate minutes, is usually enough. It should say what you do, the hours you work, the comparable pay data you looked at and the salary you chose. It costs little to prepare, and it's the first thing you'd want if the IRS ever asked.

How are an owner's health insurance premiums handled?

If you own more than 2% of the company, health insurance premiums the S corporation pays for you are deductible by the company. They're reported as wages in box 1 of your Form W-2. They're generally not subject to Social Security, Medicare or federal unemployment tax when paid under a plan for employees (IRS).

The Form 1120-S instructions add that the premiums appear in box 14 of your W-2, and you may be able to deduct them on Schedule 1 of Form 1040 (IRS Form 1120-S instructions). Your payroll provider has to report them correctly before year-end W-2s go out.

What should you do before December 31?

• Compare year-to-date wages with distributions. If you've taken large distributions and little salary, decide now whether a year-end bonus through payroll makes sense.
• Write down your basis for the number: duties, hours and comparable pay data. Keep it with your corporate records.
• Confirm your health premiums run through payroll so they land on your W-2.
• Coordinate the salary with your retirement plan and with your tax preparer's QBI estimate.
• Check Form 1125-E. If the business's total receipts are $500,000 or more, officer pay is reported on that form (IRS).

If you're still deciding whether an S corporation is the right structure, our guide to choosing an LLC, C corp or S corp covers the trade-offs. Our posts on reducing small business taxes and buying equipment before year-end cover other moves to coordinate with owner pay.

How can Mercer Street help?

At Mercer Street, we work with business owners on the planning side: modeling salary and distribution scenarios, coordinating with retirement contributions, and documenting the reasoning for your CPA or tax preparer. We don't prepare tax returns.

Mercer Street's work is billed at $600 per hour with a 2-hour minimum ($1,200). Our services page explains how engagements work.

If you want to settle your 2026 owner pay before payroll closes, schedule a free fit meeting. Fit meetings are virtual, and we can talk through whether a focused review makes sense for you.