To pay yourself in an S corp, you must take a "reasonable salary" via W-2 payroll, subject to FICA taxes, and can take additional profits as tax-advantaged distributions; the amount depends on your role's market value, not arbitrary rules like the 60/40 guideline, though some use it as a starting point for reasonable compensation to save on employment taxes. The key is to pay yourself what someone else would earn for similar work, balancing salary and distributions to meet IRS guidelines while optimizing tax savings.
S-Corp reasonable salary is the market-rate compensation you must pay yourself before taking distributions, typically ranging from $40,000-$150,000+, depending on your role, industry, and location. The IRS requires this to prevent payroll tax avoidance, with penalties reaching 20% plus interest for non-compliance.
Note: The S Corp “reasonable salary” requirement only comes into play if you (and other shareholders) take distributions from the company's profits. The IRS can't impose a minimum salary requirement, so don't fret if your business isn't earning enough yet to pay yourself a salary comparable to others in your field.
Putting your kids on payroll can shift income into their lower tax brackets. Wages up to the standard deduction ($15,000 in 2025) can be tax-free for the child. Tax treatment differs by entity type: LLCs avoid payroll taxes for children under 18, but S Corps and C Corps do not.
The "2% rule" for S Corporations treats shareholders owning more than 2% of the company's stock (or voting power) differently for fringe benefits, classifying them like partners in a partnership, not regular employees; this means benefits like health insurance premiums paid by the S Corp must be included as taxable wages on their W-2, rather than being tax-free, though the shareholder can often deduct these premiums as an "above-the-line" deduction. This rule prevents them from participating in tax-advantaged Section 125 cafeteria plans, making benefits like Health FSAs unavailable on a pre-tax basis.
Taking an S Corp election allows business owners to split their income and earnings between payroll and ordinary income. Ordinary income is not subject to self-employment taxes because the income of an S Corp is generally taxed to the shareholders of the corporation rather than to the corporation itself.
The IRS $600 rule refers to a change in reporting requirements for third-party payment apps (like Venmo, PayPal) for taxable income from goods and services, where platforms must send a Form 1099-K if you receive over $600 in a year, intended to capture gig economy/side hustle income, though delays and phased implementation have adjusted the timeline, with current rules for 2024 using a higher threshold ($5,000) before fully phasing to $600 for future years, but remember all taxable income, regardless of form, must always be reported.
Even if an S Corp has no income, it must file IRS Form 1120S annually to maintain compliance. Filing establishes a tax record, prevents IRS assumptions about tax liability, and avoids penalties. Business expenses can still be deducted, potentially resulting in a loss that carries forward.
In most cases you would keep your salary lower and pay yourself dividends as it is more tax efficient. It is important to note that dividends can only be paid if a company has made a profit, so past losses could mean the only way to take more money out of the business is via salary not dividends.
The IRS will not object to the S- Corp making zero payments to the owner employee when the business is earning little or no income. But, when the business is making money, it must first pay the owner-employee a reasonable compensation before making any payroll tax-free distributions with any excess funds.
Taxes. While LLCs and S corporations are both pass-through entities, S corporations may have preferable self-employment taxes compared to the LLC because the owner can be treated as an employee and paid a reasonable salary. Taxes, including FICA, are taken out of that salary.
The Complete List of S Corp Tax Deductions
Your S corporation can have a net loss for the year and do something that causes a salary. And if the IRS and/or the courts find that your S corporation did not pay you reasonable compensation, you can experience a new surprise salary, payroll taxes, and penalties. This will make your bad year worse.
S-Corp election lets you split your profits into “shareholder wages” (subject to 15.3% self-employment taxes) and “distributive share” (NOT subject to 15.3% self-employment taxes). Active owners in an S-Corp must pay themselves a reasonable salary, but realize a 15.3% savings on the rest of their retained profits.
S corp income can be passive or non-passive, depending on material participation. Passive income includes rental activities, limited partnerships, and royalties where the taxpayer is not materially involved.
Best Practices for Running Payroll for an S-corp