S Corporation Reasonable Salary Requirements for Solopreneurs and Freelancers

by | Jan 31, 2025 | Blog, Sole Proprietorship vs S Corp

Choosing to start your own S corp can be a great idea. However, the IRS expects you to pay yourself a “reasonable” salary—a term that can seem ambiguous at first. Below, we’ll breakdown how the process works so you can come up with an S corporation reasonable salary and avoid the ire of the IRS.

The Internal Revenue Service (IRS) estimates that there are more than five million S corporations (S corps) operating throughout the country. The reason behind the pervasiveness of these businesses is simple: They provide a legal mechanism that allows small business owners to avoid the double taxation of a C Corp while still reaping some amazing tax advantages.

What is an S Corp?

An S corp is a business or enterprise that passes its income, deductions, credits, and losses through to its shareholders. In other words, the corporation itself does not get taxed at the federal level. Instead, everything is reported on the owners’ tax returns, avoiding double taxation.

If you file taxes as a self-employed individual, you aren’t technically “double taxed,” but the hefty tax burden can certainly feel like it. You will be responsible for paying both the employer and employee portions of payroll taxes, specifically Social Security and Medicare. Together, those payments are often referred to as the self-employment tax, which currently sits at 15.3%.

If you worked for a company, your employer would cover about half of these taxes, and you pay the other half. However, as a self-employed person, you must pay the full 15.3% unless you have an S corp. To qualify as an S corp, a business must meet several requirements which can be found on the IRS Website.

Determining an S Corporation reasonable salary

Generally, many follow a 50/50 rule, which means you would claim 50% of the company’s net earnings as your salary and pay taxes on it. You wouldn’t have to pay self-employment taxes on the remaining money because they would be distributed to you as a K-1, or a partner’s share of income.

For instance, let’s say that your S corp earned $200,000 after expenses in 2024. If $100,000 goes to you in the form of compensation, you’d have to pay payroll taxes on that amount. The other $100,000 would not be subject to self-employment taxes.

You can justify paying yourself less than 50% salary if there are extenuating circumstances. For instance, if you have documented business expenses that eat away at a large portion of your gross revenue, you could potentially pay yourself less. Or in some cases you have to pay more to meet requirements like minimum wage or what might be considered “reasonable” in the eyes of the IRS.

How to calculate an S Corp salary for owners

When calculating an S corp salary for owners, you should consider the following factors:

  • Roles: The duties and responsibilities you perform within the business.
  • Industry Comparisons: The amount that other business owners in your industry are being paid.
  • Company Revenue: The more successful your business is, the higher your reasonable compensation should be.
  • Experience and Education: Your qualifications and the level of expertise required for your role.

The bottom line is that you have to justify the salary you pay (or don’t pay) yourself to the IRS. If you get audited, you will have to provide supporting documentation to substantiate the amount of pay you claimed on your tax returns.

Setting up and maintaining an S corp can be tricky, which is why you shouldn’t go about it alone. Working with a professional can help keep you out of any sort of hot water and minimize the risks of an audit.

Why does the IRS care about reasonable salaries?

The IRS closely monitors S corporation salaries because they directly impact payroll tax collection. Salaries are subject to employment taxes like Social Security and Medicare, but distributions are not. If an S corporation owner pays themselves primarily through distribution as opposed to salary, they could be unfairly reducing their tax liability. And that is why the IRS requires you to pay yourself a reasonable wage.

S Corp salary for owners: key factors to consider

Here are some things to think about when crunching the numbers to come up with S corp reasonable compensation.

  • Market conditions
  • The size and profitability of your business
  • How much time do you invest in the company

By factoring in these considerations, you can create a reasonable salary that aligns with both IRS expectations and your company’s financial health.

How to pay yourself as an S Corporation owner

Once you’ve determined your S corp reasonable salary, your next step is to make sure you’re paying yourself correctly. Here are a few simple steps for doing that:

  • Set up a payroll system to automate payments and ensure you are withholding taxes.
  • Pay yourself regularly (monthly, biweekly, or weekly).
  • Withhold Social Security and Medicare.
  • Track any distributions you pay yourself after your salary.

By following these steps, you can pay yourself as an S corp owner in a way that meets IRS requirements and reduces your tax liability.

Benefits of setting a reasonable S Corp salary

Setting a reasonable salary for your S corp will accomplish the following:

  • IRS compliance reduces the risk of audits and penalties.
  • Builds credibility with investors and potential business partners.
  • Simplify personal and business finances.
  • Make your finances more transparent and credible.
  • Can help with income verification to have pay stubs for various types of loans or applying for rental properties.
  • Ensure you are benefiting from S corp tax advantages, maximize your tax savings as a result.

You don’t want to be audited by the IRS. And you definitely don’t want to find out that you did something wrong and subsequently risk paying back taxes or incurring financial penalties. That’s why setting a reasonable S corp salary is so important. You’ll have the peace of mind that comes from knowing your business is on solid financial ground while also maximizing the advantages of an S corp structure.

Common mistakes to avoid when setting an S Corporation reasonable salary

While understanding how to determine your salary is essential, knowing what mistakes to avoid is equally significant. Common pitfalls that S corp owners should steer clear of include the following

  • Underpaying – Paying yourself too little can trigger an audit and lead to fines or back taxes
  • Overpaying – Excessive salaries can strain your business financially
  • Inconsistent Payments – Irregular payroll practices can raise red flags with the IRS

It’s important to align yourself with a knowledge team that can create a compliant S corp that provides tax benefits and legal protections. An S Corp expert, like a CPA or the Besolo team, can help you determine a reasonable S corp salary for owners and avoid these common missteps.

Get your S Corp reasonable salary right

Setting a reasonable salary for yourself as an S corp owner is key to maintaining compliance and optimizing your tax strategy. Joining an S Corp support platform that focuses specifically on creating S corps for small business owners can be the easiest way to set your S corp salary properly.

Visit Besolo to learn more and take the guesswork out of managing your S corporation.

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