S Corp owners must pay themselves a "reasonable salary" (W-2 wages) before taking distributions, typically defined as what a similar business would pay for the same services. While no specific ratio is mandated by the IRS, a common, unofficial guideline is to follow a 60/40 split between salary and distributions, respectively, to balance tax savings with compliance.
The 60/40 rule is a simple approach that helps S corporation owners determine a reasonable salary for themselves. Using this formula, they divide their business income into two parts, with 60% designated as salary and 40% paid as shareholder distributions.
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.
A commonly touted strategy to set your S Corp salary is to split revenue between your salary and distributions — 60% as salary, 40% as distributions. Another common rule, dubbed the S Corp Salary 50/50 Rule is even simpler, with 50% of the business income paid in salary and 50% in profit distribution.
You may or may not have heard of the S Corp Salary 60/40 rule. The guideline encourages setting reasonable compensation between 60% and 40% of the business's net profits.
The premise behind the 70/30 rule is that historically, economic output is made up of about 70 percent returns to labor and 30 percent returns to capital, so that ratio should also apply to the income of pass through business owners.
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.
Operating as an S corporation provides a way to reduce the amount of self-employment tax that the owners must pay because an owner can also be a corporate employee. This means that owner-employees can receive money from the corporation in two ways: Dividends: No employment tax is due on amounts received as dividends.
Health Reimbursement Arrangements (HRAs): HRAs allow companies to reimburse employees for certain medical expenses, including wellness-related costs like gym memberships, in some cases. However, for S-Corp owners, reimbursement of personal health costs may be considered taxable income.
Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income.
Can an S Corporation Reimburse a Personal Vehicle? Yes. An S Corporation can reimburse you for using your personal car for business purposes. However, you must use what's called an Accountable Plan — a reimbursement arrangement that meets IRS requirements to avoid the payment being treated as taxable income.
The 50 | 30 | 20 rule is a simple budgeting method that can help keep your finances on track. It breaks down to 50% of income for essentials, 30% for wants, and 20% towards savings or debt. Following this or other budgeting methods can help you achieve financial independence.
To run payroll for your S-corp, you must obtain a federal employer identification number (EIN), calculate payroll taxes, and file quarterly and annual tax forms. These include Social Security and Medicare contributions and federal and state income tax withholdings.
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.
The Complete List of S Corp Tax Deductions
You can't entirely avoid taxes on a bonus, but you can significantly lower the amount by contributing to tax-advantaged accounts (401(k), IRA, HSA), deferring the bonus to a year you expect to be in a lower tax bracket, or making charitable donations, thereby reducing your taxable income or increasing deductions at tax time.