A reasonable S corp salary is what a business like yours would pay someone else to do the work you do, for the hours you put in. The tax code and regulations contain no specific guidelines for it, and there is no percentage safe harbor. The practical method is to look up market pay for your occupation in BLS wage data, adjust for your experience and hours, write down how you got the number, and pay it as W-2 wages through payroll before you take distributions.
Why does an S corp owner have to take a salary at all?
If you work in your S corp and take money out, part of it has to be wages; this is the S corp piece of how to pay yourself from an LLC. Federal law counts any officer of a corporation as an employee for Social Security and Medicare purposes. The only exception is an officer who performs no services or only minor services and receives no pay.
The Form 1120-S instructions say distributions and other payments to a corporate officer must be treated as wages to the extent they are reasonable compensation for services.
Salary carries Social Security and Medicare tax (15.3% combined, split between you and the company); distributions do not. That gap is the S corp's payroll-tax saving; whether it outweighs the cost of running payroll is covered in when an S corp election makes sense.
What does "reasonable" mean to the IRS?
Reasonable compensation is generally the amount that "would ordinarily be paid for like services by like enterprises under like circumstances," per Treasury Regulation §1.162-7(b)(3). With no specific guidelines in the Code, courts decide case by case.
The IRS lists factors courts have considered: your training and experience; duties and responsibilities; time and effort devoted to the business; dividend history; pay to non-owner employees; timing and manner of bonuses to key people; what comparable businesses pay for similar services; compensation agreements; and use of a formula to set compensation.
The IRS also says receipts that come from the owner's own services, as opposed to other employees or capital and equipment, should be paid as wages. For a solo owner with no staff and little equipment, that is most of the revenue.
Is the 60/40 rule a safe harbor?
No. The "60/40 rule" (60% of profit as salary, 40% as distributions) is a rule of thumb passed around online, not an IRS rule. No IRS source sets a percentage split, and a fixed split ignores the benchmark courts lean on: what the job pays in the market.
60/40 ties your salary to profit, not to what your work is worth. Take a full-time graphic designer whose market median is $62,960 a year (BLS, May 2025):
| Year's profit | 60% "rule" salary | Compared with the $62,960 market median |
|---|---|---|
| $120,000 | $72,000 | About $9,000 above; more payroll tax than the market requires |
| $90,000 | $54,000 | About $9,000 below; harder to defend |
Same job, same hours, two different salaries. The "use of a formula" factor above is something courts have looked at, not an endorsement of 60/40.
How do I find a defensible number?
Start from market pay for the work you do, then adjust for your situation. The IRS's Reasonable Compensation Job Aid, written for its own valuation staff, describes three approaches. It says it is not an official IRS position, but it shows how examiners think.
- Market approach. What a non-owner is paid for your job at a similar company. The Job Aid calls it the most commonly used, and it is the main method for most solo owners.
- Cost approach. Split your actual hours across the roles you perform and price each role. The Job Aid calls this the least used and warns against adding up full-time salaries for several roles.
- Income approach. Whether an outside investor would accept the return left after your pay. It needs a business valuation, so it rarely fits a one-person company.
Using BLS wage data
The Bureau of Labor Statistics publishes Occupational Employment and Wage Statistics (OEWS) for about 830 occupations; the latest release covers May 2025. Pay varies by location, so use the OEWS data search for your state or metro. Graphic designers' median annual wage was $62,960 nationally, $60,150 in Texas, and $75,130 in California.
Treat the median as a starting point. Adjust down if you are new to the field, work part time, or run a small operation, and up if you have deep experience. Write down the source, occupation code, date, and reasoning, and keep it with your corporate records.
How courts have used wage data
In David E. Watson, P.C. v. United States (8th Cir. 2012), a CPA with nearly 20 years of experience took a $24,000 salary from his S corp in 2002 and 2003 and the rest of its cash as dividends, after it received $203,651 and $175,470 in profit distributions from his accounting firm. An IRS expert used an accounting-industry pay survey to value his work at $91,044 a year. The court upheld treating $67,044 a year of the dividends as wages and was not persuaded that the company's stated intent to pay only $24,000 in salary controlled.
In Sean McAlary Ltd v. Commissioner, a 2013 Tax Court summary opinion, a real estate broker took $240,000 from his S corp with no W-2. The IRS's expert multiplied the southern California median wage for real estate brokers, $48.44 an hour, by 2,080 hours ($100,755); the court cut the rate to $40 an hour ($83,200) for the owner's limited experience and small operation. Summary opinions are not precedent and bind no other case, so read McAlary as an illustration of the method (a state wage median times hours, adjusted for the owner), not as a rule.
Worked example: a solo graphic designer
One full-time, experienced graphic designer owns the S corp and has no employees. Net profit before the owner's salary is $120,000, and payroll runs in 2026.
Market approach. The national median for graphic designers is $62,960, so the owner sets salary at $63,000.
| Item | Math | Amount |
|---|---|---|
| Salary | $63,000.00 | |
| Employer Social Security + Medicare | $63,000 × 7.65% | $4,819.50 |
| Employee Social Security + Medicare (withheld) | $63,000 × 7.65% | $4,819.50 |
| FUTA, assuming full state credit | $7,000 × 0.6% | $42.00 |
| Left for distributions | $120,000 − $63,000 − $4,819.50 − $42 | $52,138.50 |
Employer and employee each pay 6.2% Social Security and 1.45% Medicare, and all $63,000 is under the 2026 Social Security wage base of $184,500. FUTA is 6.0% on the first $7,000, or 0.6% after the full state credit; state unemployment insurance is extra. The distributions escape Social Security and Medicare tax but are still income on your personal return.
Cost approach, same owner. 2,080 hours split by how the owner spends the year, priced at May 2025 national median hourly wages from BLS OEWS:
| Role | Hours | Median hourly | Amount |
|---|---|---|---|
| Graphic design (75%) | 1,560 | $30.27 | $47,221.20 |
| Running the business: general and operations manager (15%) | 312 | $50.85 | $15,865.20 |
| Bookkeeping and admin (10%) | 208 | $24.36 | $5,066.88 |
| Total | 2,080 | $68,153.28 |
The two methods land about $5,000 apart, and either is a market-based number you can document. A $24,000 salary, as in Watson, is not.
What happens if the IRS decides my salary was too low?
The IRS reclassifies part of your distributions as wages and bills the company for the missed Social Security and Medicare tax, plus penalties and interest. In the example above, paying $24,000 instead of $63,000 leaves $39,000 outside Social Security and Medicare tax; at 15.3%, that is $5,967 a year. On top of the tax:
- Failure-to-deposit penalties of 2% to 10% depending on lateness, or 15% if unpaid more than 10 days after the first IRS notice
- A possible 20% accuracy-related penalty on the underpayment
- Interest on the tax and penalties
- Failure-to-file penalties if you never filed payroll returns, as the Tax Court applied in McAlary
Calling the money a shareholder loan does not help. The IRS names loans alongside distributions and paid personal expenses as ways S corps should not avoid employment taxes, and lists cases where purported loans were treated as wages.
Do I need a salary in a loss year or a slow first year?
Only if you take money out. The IRS says compensation will never exceed the amount received by the shareholder, directly or indirectly, such as personal expenses the company pays for you. If profit stays in the business and you take nothing, no wage is required.
If you take money out while working in the business, it is wages first, up to a reasonable amount. Say your first year nets $15,000, you work full time, and you take all of it: full-time work is worth more than that, so all $15,000 runs through payroll. For scale, 2,080 hours at the $7.25 federal minimum wage is $15,080, and many states set a higher minimum. Minimum wage is not an IRS test, but full-time pay below it is hard to call reasonable.
Does the salary have to go through real payroll?
Yes. Your salary is W-2 wages: the company withholds income tax and your share of Social Security and Medicare, adds its share, and deposits both under Publication 15 rules. It files Form 941 quarterly, Form 940 annually, and a W-2 for you.
Payroll tax deadlines for 2026 has the full calendar, and running payroll when you're the only employee walks through the setup. Distributions have no withholding, so you may need quarterly estimated taxes on them.
What to do next
- Look up your occupation for your state or metro in the BLS OEWS data search, pricing each role's hours if you split your time.
- Adjust for your experience, hours, and business size, and write a short memo with your sources and reasoning. Revisit it each year.
- If your profits are high, your number is near the low end, or you took distributions without salary in past years, have a CPA review it. Reasonableness turns on your specific facts, and a CPA can weigh them against the case law.
- Set up payroll for yourself before you take distributions. CheckMate calculates your withholding and payroll taxes, pays you by direct deposit, generates your W-2 and Form 941, and emails reminders before deadlines. It charges only when you run payroll. You still file and pay the taxes yourself.
FAQ
Can I take only distributions and no salary? Not if you work in the business and take money out. In Radtke (E.D. Wis. 1989), as described in the Watson opinion, an S corp paid its sole shareholder-employee dividends and no salary, and the court held the dividends were wages.
Does my health insurance count toward my salary? Premiums the S corp pays for a more-than-2% shareholder go in W-2 box 1 and are exempt from Social Security, Medicare, and FUTA. We found no IRS guidance on whether they count toward a reasonable salary, so ask your CPA; the reporting rules are in how S corp owners deduct health insurance.
Does a higher salary affect the QBI deduction? Yes. Reasonable compensation from an S corp is excluded from qualified business income, so a higher salary lowers the income the deduction is figured on. It does not change what counts as reasonable.
Sources
- IRS, Fact Sheet FS-2008-25, "Wage Compensation for S Corporation Officers" (August 2008). https://www.irs.gov/pub/irs-news/fs-08-25.pdf
- IRS, "S Corporation Compensation and Medical Insurance Issues" (last reviewed March 3, 2026). https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues
- IRS, "S Corporation Employees, Shareholders and Corporate Officers" (last reviewed July 4, 2026). https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-employees-shareholders-and-corporate-officers
- IRS, Instructions for Form 1120-S (2025). https://www.irs.gov/instructions/i1120s
- 26 U.S.C. §3121(d), definition of employee. https://www.law.cornell.edu/uscode/text/26/3121
- 26 C.F.R. §31.3121(d)-1, who are employees. https://www.law.cornell.edu/cfr/text/26/31.3121(d)-1
- 26 C.F.R. §1.162-7, compensation for personal services. https://www.law.cornell.edu/cfr/text/26/1.162-7
- IRS, Reasonable Compensation Job Aid for IRS Valuation Professionals (October 2014; not an official IRS position). https://www.irs.gov/pub/irs-lbi/Reasonable%20Compensation%20Job%20Aid%20for%20IRS%20Valuation%20Professionals.pdf
- David E. Watson, P.C. v. United States, 668 F.3d 1008 (8th Cir. 2012). https://ecf.ca8.uscourts.gov/opndir/12/02/111589P.pdf
- Sean McAlary Ltd, Inc. v. Commissioner, T.C. Summary Opinion 2013-62 (non-precedential). https://www.courtlistener.com/opinion/1037447/sean-mcalary-ltd-inc-v-commissioner/
- U.S. Bureau of Labor Statistics, Occupational Employment and Wage Statistics, May 2025. https://www.bls.gov/oes/ and https://data.bls.gov/oes/
- BLS, OEWS occupation profile: Graphic Designers (27-1024). https://www.bls.gov/oes/current/oes271024.htm
- IRS, Topic No. 751, Social Security and Medicare Withholding Rates. https://www.irs.gov/taxtopics/tc751
- IRS, Topic No. 759, Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return. https://www.irs.gov/taxtopics/tc759
- IRS, Publication 15 (2026), Employer's Tax Guide. https://www.irs.gov/publications/p15
- IRS, Failure to Deposit Penalty (last reviewed February 24, 2026). https://www.irs.gov/payments/failure-to-deposit-penalty
- IRS, Accuracy-Related Penalty (last reviewed May 6, 2026). https://www.irs.gov/payments/accuracy-related-penalty
- 26 U.S.C. §199A(c)(4), treatment of reasonable compensation. https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section199A&num=0&edition=prelim
- U.S. Department of Labor, Minimum Wage. https://www.dol.gov/agencies/whd/minimum-wage
- U.S. Department of Labor, State Minimum Wage Laws. https://www.dol.gov/agencies/whd/minimum-wage/state