If you own an S-Corporation, setting your salary is not something you can guess. The IRS requires you to pay yourself a “reasonable salary” before taking profits. If you don’t follow this rule, you could face penalties, back taxes, and even an audit. The goal is to find a balance where your salary makes sense and keeps you compliant.
What “Reasonable Salary” Really Means
A reasonable salary is what someone would normally get paid for doing your job. Think about your role in the business. Are you managing everything, handling clients, and doing the work? Then your salary should reflect that.
If someone else had your responsibilities, what would you pay them? That’s the idea behind a reasonable salary.
How to Figure Out the Right Amount
There’s no exact number, and that’s why people get confused. Your salary depends on your industry, your experience, how much work you do, and how profitable your business is. A business owner doing most of the work should not be paying themselves a very low salary.
Looking at market rates for similar positions can help, but your real situation matters more than averages.
What Happens If You Get It Wrong
This is where things can get expensive. If the IRS decides your salary is too low, they can reclassify your profits as wages. That means you’ll owe back payroll taxes, plus penalties and interest. Penalties can include failure to pay payroll taxes, which can be up to 25% of the unpaid amount. On top of that, interest keeps building until everything is paid.
If payroll taxes were never filed correctly, additional penalties can apply for late filings and incorrect reporting. In serious cases, it can trigger a full audit. Trying to save on taxes the wrong way can cost you much more later.
Why Guessing Is a Bad Idea
Many business owners hear that S-Corps save money and try to push the limits. They pay themselves a very small salary and take the rest as profit. This might work for a short time, but it increases your risk. The IRS knows this is a common mistake, and it’s one of the first things they look at when reviewing S-Corps.
Final Thoughts
Setting a reasonable salary is not just about saving money. It’s about doing things the right way. If your salary is too low, you risk penalties and audits. If it’s set correctly, you can still take advantage of S-Corp benefits without the stress. If you’re unsure, don’t guess. Getting it right from the beginning can save you a lot of trouble later.
How Local Tax Can Help
At Local Tax, we help S-Corp owners in Bellflower and across Los Angeles County set a salary that makes sense and keeps them protected. We look at your business, your role, and your income to determine a reasonable salary that won’t raise red flags. We also handle payroll, bookkeeping, and tax filings, so everything is done correctly from the start.
Local Tax
9429 Somerset Blvd, Bellflower, CA 90706
(562) 925-2203
