A reasonable S Corp owner salary is what you'd pay someone else for the same job, typically determined by industry standards, your role's responsibilities, experience, and business profitability, often guided by rules of thumb like 60/40 or 50/50 salary-to-distribution splits, but these aren't strict formulas. The key is paying enough to satisfy the IRS's "reasonable compensation" rule to avoid payroll tax savings on distributions, so look at BLS salary data and industry benchmarks for similar roles.
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.
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.
S-Corp strongly opposed it then, and we oppose it now. 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.
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.
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.
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.
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 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.
Common S Corp Deductions
For an S Corp owner, there are some tax benefits to having the company pay for your health insurance. As long as you follow the rules and treat the payments correctly, you'll be able to take advantage of some tax savings for both the company — and for you as a shareholder.
The IRS uses a combination of automated and human processes to select which tax returns to audit. Not reporting all of your income is an easy-to-avoid red flag that can lead to an audit. Taking excessive business tax deductions and mixing business and personal expenses can lead to an audit.
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.
The biggest mistake small businesses make is neglecting to plan thoroughly.