S-corp reasonable salary: the basics
Reviewed by the Nexus by State research team against IRS forms, instructions and the Internal Revenue Code (sources below).
An S corporation must pay a shareholder who works in the business reasonable compensation for those services before it makes non-wage distributions. Wages carry payroll taxes; distributions do not, which is why the IRS watches the split.
What the IRS says
S corporations must pay reasonable compensation to a shareholder-employee in return for services the employee provides before non-wage distributions may be made. The IRS can reclassify distributions as wages, and courts have upheld that authority (the IRS cites Joly, Veterinary Surgical Consultants, Joseph M. Grey Public Accountant and David E. Watson).
The IRS looks at the source of the gross receipts. Receipts produced by the shareholder’s own services, including administrative work supporting other income-producing employees or assets, point to wages. Receipts produced by non-shareholder employees or by capital and equipment can properly support distributions.
Factors the IRS lists
- Training and experience
- Duties and responsibilities
- Time and effort devoted to the business
- Dividend history
- Payments to non-shareholder employees
- Timing and manner of paying bonuses to key people
- What comparable businesses pay for similar services
- Compensation agreements
- The use of a formula to determine compensation
The taxes involved
- Wages: Social Security tax of 6.2% each for employer and employee (12.4% total) up to the wage base ($184,500 for 2026), and Medicare tax of 1.45% each (2.9% total) on all wages.
- Self-employment tax without the election: 15.3% (12.4% Social Security, 2.9% Medicare), generally on 92.35% of net earnings from self-employment.
- An additional 0.9% Medicare tax applies above income thresholds in both cases.
An illustration, not advice
| Amount | |
|---|---|
| Self-employment tax without the election (on 92.35% of $120,000) | $16,955 |
| Employer + employee FICA on a $60,000 salary | $9,180 |
| Difference before any other cost | $7,775 |
This leaves out income tax effects, the additional Medicare tax, state taxes and fees, payroll processing and unemployment taxes, and the cost of a separate Form 1120-S. Whether $60,000 is reasonable depends on the facts above. Run your own figures in the S-corp election checker, and set the salary with a CPA.