S-Corp Reasonable Salary: A Plain-English Method to Pick a Defensible Number
- Five Fold Group
- 4 days ago
- 7 min read
If you own an S-Corp and you work in the business, you’re wearing two hats. You’re an owner, and you’re also an employee. That employee hat matters because the IRS expects you to be paid wages for the work you actually do, not just take profits as distributions.
That’s where S-Corp reasonable salary comes in. In simple terms, it means paying yourself about what you’d have to pay someone else to do your job. If your wage is too low, the IRS can reclassify distributions as wages, then assess back payroll taxes, plus interest and penalties. The fix is not guesswork, it’s a repeatable process with basic proof.
This article gives you a plain-English way to choose a number you can explain, and a simple way to document it.
Start here: what the IRS is really looking for when it reviews your salary
There’s no single IRS formula that spits out the “right” salary. The standard is facts and circumstances. That sounds vague, but it’s also practical: the IRS is looking for a wage that looks normal for the job, in the place you live, for a business like yours.
In an audit, a salary usually gets challenged for one reason: it doesn’t match the work. The most common pattern is tiny wages paired with large distributions. The IRS knows why that happens: wages trigger payroll taxes, distributions don’t. So the review starts with a basic question, “If this person wasn’t the owner, what would we have to pay them?”
The plain-English definition you are trying to meet
A key IRS concept is paying what “would ordinarily be paid for like services by like enterprises under like circumstances.”
Here’s the one-sentence test you can use:
If you had to replace yourself tomorrow, would you offer a similar wage to hire someone competent to do the same work, for the same hours, in the same market?
If your answer is “not even close,” your salary probably isn’t defensible yet.
The factors that usually decide the answer in an audit
Most reasonable compensation debates come down to a handful of real-world details:
Duties and responsibility (client work, management, sales, oversight)
Time spent (hours per week and how consistent they are)
Skills and experience (licenses, specialized know-how, reputation)
Location and industry (a pay rate in rural Iowa won’t match San Jose)
Business size and complexity (a solo shop vs. a team of 12)
What you pay others (it’s hard to justify paying yourself less than a key employee you supervise)
How pay is structured (base pay vs. bonuses, and whether it’s consistent year to year)
Revenue matters, but it’s not the whole story. Two S-Corps can have the same profit and totally different owner workloads.
A simple 5-step method to choose a defensible S-Corp salary number
The goal is not to “optimize taxes” with a clever trick. The goal is to pick a wage that fits your work, and to keep receipts that show how you got there. You can do this in an afternoon, then update it once a year.
Step 1: Write down your real job (not your title) and your weekly hours
Start with what you actually do, not what your business card says.
Make a short list of the work you perform in a normal month: client delivery, sales calls, managing staff, bookkeeping, quoting, project planning, shipping, and so on. Then estimate hours per week.
If you wear multiple hats, split your time by role. For example: 50% billable work, 30% management, 20% admin. This matters because you’re not trying to price “CEO” in a vacuum, you’re pricing your real week.
If your hours swing by season, use a reasonable average and note it in your documentation.
Step 2: Pull pay ranges for those roles in your area and industry
Now get market pay data. Focus on sources that are easy to explain, and easy to re-check:
Bureau of Labor Statistics (BLS) wage data (a strong baseline because it’s government-published)
Major job sites with salary tools and postings (Indeed, Glassdoor, Monster, ZipRecruiter)
Compensation tools that let you filter by location and seniority (Salary.com and similar)
Match the data to your situation as closely as you can: geography, seniority, and the type of work. Don’t grab a national average for a job that’s priced very differently in your city.
When you find a range (low, mid, high), pick a point that fits your facts:
Low end often fits a lighter workload, fewer duties, or a newer business.
Middle fits steady work with standard responsibility.
High end fits deep expertise, heavy hours, or a complex role.
Step 3: Adjust the market number for part-time work, multiple roles, and business size
Keep the math simple and tied to reality.
Part-time: If market pay assumes 40 hours and you work 25, a straight prorate is a clean starting point.
Multiple roles: Build a blended number based on your time split. If you spend 60% on client work and 40% on management, don’t pretend you’re 100% either one.
Business size: A tiny local firm may not pay like a 1,000-person company. That’s fine, as long as your sources and adjustment are reasonable. Also, high profit alone doesn’t prove your job’s wage should be high. But if your business grew fast and your duties expanded (more employees, more risk, more oversight), higher pay can make sense.
Step 4: Stress-test the number against your company’s finances
A reasonable salary has to be payable. If your S-Corp net income can’t support the wage you picked, that’s a sign you may be overpricing your role or overestimating hours, or the business model needs work.
Two practical checks:
You must run salary through real payroll (with withholdings, payroll tax filings, and a W-2).
Avoid wild swings year to year unless something changed (hours, duties, market rates, or business conditions).
Some owners use a year-end bonus to “true-up” once they know the year’s results. That can work, but it still needs to be reasonable and documented.
Step 5: Write a one-page “salary memo” and save your proof
This is the difference between “I think it’s fine” and “Here’s how we set it.”
Your one-page memo can include:
Role description and main duties
Weekly hours (and any seasonality note)
Data sources used (BLS, job postings, salary tools)
Pay ranges you found
Adjustments (hours, blended roles, company size)
Final salary number and effective date
A short statement why it’s reasonable
Save PDFs or screenshots of your sources. Repeat the review annually, or anytime your duties change.
Common traps that make a salary hard to defend (and what to do instead)
A defensible salary usually looks boring. The bad setups tend to have the same “too clever” feel.
Rules of thumb that sound good but fail under scrutiny
Some popular shortcuts can backfire because they skip the facts:
“50/50 salary and distributions”: Easy, but not tied to your job, hours, or market pay.
“Pay the Social Security wage base”: In 2026, the Social Security taxable wage base is $184,500. Some owners treat that like a safe target. It isn’t a rule, and it can be too high or too low depending on your role.
“Same salary every year forever”: If your business changes, your wage often should too.
A better approach is simple: price the work using market data, then document how you adjusted it.
Red flags: tiny wages, big distributions, and no paperwork
The IRS tends to focus when it sees patterns like:
Paying yourself zero wages while taking distributions
Very low wages compared to your role and hours
Large distributions while wages stay flat
No payroll setup (no W-2, weak filings)
No support file (nothing saved, nothing written down)
Quick fixes that help:
Set wages early in the year, not in December.
If you’re behind, run a catch-up payroll or a documented bonus.
Write the memo, save the proof, then stick to the plan.
Quick examples you can copy: turning market data into a salary number
These are simplified on purpose. The point is the method and the paper trail.
Example 1: Solo consultant doing most of the client work
Jordan owns a one-person consulting S-Corp. Jordan does 90% client delivery, works about 35 hours a week, and handles basic admin.
Jordan pulls local market pay for the closest match (a comparable professional role). The ranges found across credible sources support roughly $80,000 to $150,000 for full-time, depending on location and specialty. Jordan picks a middle-leaning number based on experience, then prorates for 35 hours.
Jordan sets an annual wage that fits that logic, runs it through payroll, and saves the BLS table and a few local job postings as proof. Remaining profit after expenses and that wage can be paid as distributions, as long as the wage stays reasonable.
Example 2: Owner-manager with a small team who spends time on sales and ops
Casey owns an S-Corp with six employees. Casey works 45 hours a week, split across management (about half the week), sales (about a quarter), and admin and finance (the rest).
Casey pulls pay ranges for a small-company general manager, a sales lead role, and an admin or operations role in the local area. Casey then builds a blended salary using the time split, with a modest bump because managing people and signing off on major decisions adds responsibility.
Casey also checks internal consistency: two team leads earn solid wages, so Casey’s salary shouldn’t be oddly lower. The final number is run through payroll, and Casey writes a one-page memo with sources, time estimates, and the blended calculation.
Conclusion
A defensible S-Corp reasonable salary comes from matching pay to the work, then backing it up with evidence. Keep it simple: define your real duties and hours, pull local market ranges, adjust for your situation, stress-test against business finances, then write a short memo and save your sources.
If you want more confidence, treat that memo like a yearly checkup and ask a CPA to review the support file. The goal is not perfection, it’s reasonableness you can explain on paper.
If you would like to book a Clarity Call with our business management firm to calculate your reasonable salary, you may click here to schedule your call.
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