A reasonable salary for an S Corp owner is the amount a similar business would pay for similar services, often determined by looking at market rates, industry data, and experience. While a "60/40" split of net income (60% salary/40% distribution) is a common rule of thumb, the IRS requires a, defensible, market-based approach rather than a set percentage.
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 IRS does not set this guideline.
What is the 60/40 rule? 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.
The Income Threshold: $60,000 is the Magic Number
Because it lets you: Pay yourself a reasonable salary and cover payroll taxes. Start enjoying the tax savings from distributions that aren't subject to self-employment taxes.
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.
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.
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.
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.
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.
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.
To avoid the 22% tax bracket (or any higher bracket), focus on reducing your taxable income through strategies like maxing out 401(k)s and HSAs, deferring bonuses, tax-loss harvesting, smart charitable giving, and strategic asset location, understanding that higher rates only apply to income within that bracket, not your entire income.
S Corp salary is W-2 compensation subject to payroll taxes (Social Security, Medicare), while distributions are leftover profits paid to owners (shareholders) that are not subject to payroll taxes, offering significant tax savings, but you must pay yourself a reasonable salary first, as excessive distributions disguised as salary can trigger IRS penalties. The key difference is tax treatment, with distributions saving on employment taxes, but the IRS scrutinizes this, often looking for structures that minimize salary to avoid FICA taxes, so paying a reasonable salary (often cited as 40-60% of total comp, but not a fixed rule) is crucial for compliance.
As a result, you can pay yourself once annually. However, note that there may be an obligation to file Form 941 reports (whether you have taxes to report or not) on a quarterly basis, so you should take that into consideration.
If the records of your corporation show that the owner is receiving minimal or no salary, you are likely to face an audit. Owners of S corporations generally must be paid reasonable compensation for their services.
How can S corporations reduce their taxes?