S Corp Owners Must Set Reasonable Salary Before Taking Distributions
Accounting expert David Riggs outlines why S corp owners must document reasonable compensation before drawing shareholder distributions to avoid IRS scrutiny.
S corporation owners who take shareholder distributions without first paying themselves a reasonable salary risk drawing unwanted IRS attention, according to accounting expert David Riggs, writing in HelloNation. The guidance underscores a longstanding but frequently misunderstood requirement that working owners of S corps must treat themselves as employees before accessing profits through distributions.
The distinction matters because salary payments are subject to payroll taxes — Social Security and Medicare — while shareholder distributions are not. Riggs notes that some business owners attempt to minimize their stated salary precisely to reduce that payroll tax burden, a strategy the IRS actively scrutinizes and regularly challenges in audits.
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Determining what qualifies as "reasonable" compensation is not arbitrary. According to Riggs, key factors include the nature of the owner's duties within the business, relevant experience and qualifications, hours devoted to operations, and what comparable businesses pay for similar roles. Together, these elements form the evidentiary basis an owner would need to defend a salary figure if questioned by tax authorities.
The supporting documentation component is central to Riggs' analysis. Maintaining clear records that justify compensation decisions is described as essential, not optional. Without such records, an S corp owner may find it difficult to substantiate their position during an IRS examination, potentially exposing the business to reclassification of distributions as wages — along with associated penalties and interest.
The guidance is particularly relevant for small-business owners and sole practitioners who elect S corp status for tax efficiency. While the structure can offer legitimate savings, those benefits depend entirely on compliance with compensation rules. Continue reading at All Financial Services & Investing.
