The moment you elect S-corp status, a new rule attaches to you: before you take a single dollar of tax-advantaged distribution, you have to pay yourself a reasonable salary for the work you do. Get that number wrong on the low side and you’ve lit the brightest audit flare an S corp can light.
Why the number matters so much
Your salary gets payroll tax; your distributions don’t. So there’s an obvious temptation: pay yourself a tiny salary, take everything else as distribution, and dodge the payroll tax. The IRS has seen this exact move a hundred thousand times, and they have a word for a $0 salary with six figures of distributions — it’s “reclassified,” usually with penalties attached.
What “reasonable” actually means
The working definition: what you’d have to pay someone else to do your job. The factors that matter are your training and experience, your duties and hours, what you do to bring in the revenue, and what comparable businesses pay for comparable work. A software consultant billing $200/hour cannot credibly claim a $20,000 salary.
The cases that drew the line
This isn’t theoretical — courts have ruled on it. In the best-known case, an accountant paid himself a $24,000 salary while pulling roughly $200,000 out of his firm; the court decided about $91,000 was the reasonable number and the rest got reclassified as wages. Other cases (Glass Blocks, McAlary) landed the same way for the same reason: the salary was implausibly low for the work being done.
There’s a balance here: too low invites the audit, too high hands back the savings that made the S corp worth electing in the first place. The sweet spot is the defensible one.
Our Decision Kit walks the reasonable-comp method in plain English — including the court cases and how to benchmark your role — and the calculator shows exactly how your salary choice changes what you save.
LLC or S-Corp? The Business Structure Decision Kit
Stop guessing with rules of thumb. Run your profit, your salary, your state through an honest calculator, a 2-minute decision tool, and a plain-English guide.
