How to Balance Salary vs Distribution in Your S-Corp
- S-Corp Guide
- Nov 16
- 7 min read
If you're running an S-Corporation, you face a tax decision every single year that could cost you thousands: how much should you pay yourself in salary versus distributions?
Pay yourself too much salary? You're wasting money on unnecessary payroll taxes.
Pay yourself too little? The IRS might come knocking with penalties and back taxes.
Most business owners guess at this number. Or worse—they just copy what someone else does, even though their situation is completely different. Here's the thing: there's actual math behind finding your optimal split. And once you understand the tax mechanics, you can make this decision with confidence.
Why the Salary vs Distribution Split Matters
S-Corporations have a unique tax structure that creates both an opportunity and a trap.
The Opportunity: When you pay yourself a salary, both you and your business pay payroll taxes (Social Security and Medicare). That's 15.3% total—7.65% from your paycheck and 7.65% paid by the business. But distributions? They're not subject to payroll taxes at all. Zero. That's where S-Corp owners save money.
The Trap: The IRS knows about this tax advantage of using distributions to avoid taxes. So they have one simple rule: you must pay yourself "reasonable compensation" for the work you do in your business. Pay yourself $30,000 in salary while taking $200,000 in distributions as the CEO who runs everything? That wouldn't be reasonable in the eyes of the IRS, and they will reclassify those distributions as salary and hit you with penalties plus back taxes on that 15.3% you tried to avoid.
Let's look at an example:
Suppose your S-Corp nets $150,000 annually.
Scenario A: All salary (the overly cautious approach)
Salary: $150,000
Distributions: $0
Payroll taxes: $22,950 (15.3% of $150,000)
Scenario B: Balanced split
Salary: $75,000
Distributions: $75,000
Payroll taxes: $11,475 (15.3% of $75,000)
Annual savings: $11,475 just by finding the right split.
But here's where it gets tricky: the "right" split isn't the same for everyone. It depends on your income level, your role in the business, and what's considered reasonable in your industry. If you'd like to dive in deeper on ins-and-outs of how S Corp taxes work, check out our in-depth article on S Corp Taxation.
What Does "Reasonable Compensation" Actually Mean?
The IRS doesn't publish a magic number or formula. Instead, they look at factors like:
Your duties and responsibilities - Are you the CEO doing everything, or do you have a limited role?
Time spent working - Full-time involvement supports higher salary requirements
Industry standards - What would someone in your role earn at a comparable company?
Your company's income - Higher business income generally requires higher salary
Your qualifications - Education, experience, and expertise matter
The safe harbor that most tax professionals use: pay yourself what you'd have to pay someone else to do your job. If you'd need to hire someone for $80,000 to replace yourself, that's probably your minimum reasonable salary. But that still leaves a question: Should you pay yourself MORE than the minimum to optimize your total tax burden?
This is where the math gets interesting.
How to Find YOUR Optimal Salary vs Distribution Split
Here's the counterintuitive part: sometimes paying yourself a higher salary actually lowers your total tax bill.
How? Two reasons:
1. The QBI Deduction Sweet Spot
The Qualified Business Income (QBI) deduction lets you deduct 20% of your business income from your taxable income. But for S-Corps, this deduction is calculated on your business net income, not your salary.
Higher salary = lower business net income = smaller QBI deduction
At certain income levels, this can mean paying yourself too low a salary backfires because you lose more in QBI deductions than you save in payroll taxes.
2. Progressive Tax Brackets
Federal income tax brackets are progressive. Sometimes, the combination of:
Payroll tax savings on distributions
Federal income tax on your total income
QBI deduction calculations
State tax implications
could create an optimal salary point that's higher than the bare minimum. The only way to know your optimal split is to run the actual numbers for YOUR situation.
Use the Calculator to Find Your Number
This is exactly why we built the S-Corp Salary vs Distribution Calculator - to give you the tools you need to run the numbers for your unique and specific situation, weigh the tax impacts, and find your optimal range.
Here's how to use it:
Step 1: Start with your business net income
This is your profit before paying yourself. If your business made $150,000 after all expenses (except your compensation), enter $150,000.
Step 2: Try different salary amounts
Start with what you think is reasonable compensation. Then adjust up and down by $10,000-$20,000 increments.
The calculator shows you:
Total payroll taxes at each salary level
How your QBI deduction changes
Your complete federal and state tax picture
Your total tax burden for each scenario
Step 3: Look for the sweet spot
You're looking for the salary amount where your total tax is lowest while still being defensible as reasonable compensation.
Step 4: Verify it passes the "reasonable" test
Once you find your optimal number mathematically, ask yourself: "Would I pay someone else this amount to do my job?"
If yes, you've found your answer.
If no, adjust upward until it passes that test.
The Step-by-Step Process For S Corp Salaries
We've developed an action plan for you to lock in your S Corp salary and let you focus on running your business:
Calculate your estimated net business income for the year (or use last year's actual number)
Research reasonable compensation in your industry for your role
Check salary websites like Glassdoor or Salary.com
Talk to your tax professional about industry standards
Document your research (helpful if ever questioned)
Run multiple scenarios in the S-Corp Salary vs Distribution Calculator
Start with your reasonable comp estimate
Test amounts $20K above and below
Look for the lowest total tax burden
Choose your salary based on:
The number that minimizes taxes while
Still being defensible as reasonable compensation
Set up your payroll at that amount
Most owners pay themselves monthly or semi-monthly
Use a payroll service (Gusto, ADP, etc.) to ensure proper withholding
Take distributions as needed throughout the year
These can be irregular (whenever you need cash)
Just track them for your records
Document your decision
Keep notes on how you determined reasonable compensation
Save any salary research you did
This documentation is gold if the IRS ever questions your split
Common Mistakes to Avoid
Mistake #1: Ignoring reasonable compensation
Some owners try to pay themselves $20,000 in salary while taking $180,000 in distributions. This is asking for IRS trouble. The payroll tax savings aren't worth the audit risk and penalties.
Mistake #2: Being too conservative
Other owners are so worried about the IRS that they pay themselves $150,000 in salary when $75,000 would be perfectly reasonable and would save them $11,000+ in taxes.
Mistake #3: Setting it once and forgetting it
Your optimal split changes as your business income changes. If you netted $100,000 last year but you're on track for $200,000 this year, your salary should probably increase too.
Run the numbers annually.
Mistake #4: Not considering state taxes
Some states (like California, New York, New Jersey) have high income taxes. The calculator accounts for this, but make sure you're entering your correct state tax rate.
Mistake #5: Confusing gross revenue with net income
Your salary vs distribution decision is based on net business income (profit), not gross revenue. If you had $500,000 in revenue but $400,000 in expenses, your net income is $100,000—that's what matters.
What About Quarterly Estimates?
Once you determine your optimal salary, you'll need to pay quarterly estimated taxes on your anticipated net income. Payroll taxes won't fully cover your tax obligations for the year, so its important to ensure you're covered through quarterly estimates. Here's the quick, high-level look at how this works:
Your salary handles payroll taxes automatically through withholding
Your net income requires quarterly estimated tax payments for federal and state income tax
Use your calculator results to determine your estimated tax liability
Divide by 4 and pay quarterly (April, June, September, January)
Your tax professional can help you set up these quarterly payments, or you can pay directly through IRS Direct Pay.
Your Next Steps
The salary vs distribution decision doesn't have to be complicated or stressful.
You now understand the tax mechanics: payroll taxes on salary, QBI deduction calculations, and the reasonable compensation requirement.
Here's what to do right now:
Pull up last year's tax return or your current year profit projection
Head to the S-Corp Salary vs Distribution Calculator
Run 3-5 different salary scenarios
Find your optimal number
If you're working with a tax professional, share the results and confirm it meets the reasonable compensation test
The difference between guessing and optimizing this decision could easily be $5,000-$15,000 annually in tax savings.
Keep Learning
Want to stay on top of S-Corp strategies like this? Join business owners who are learning to keep more of what they earn.
Frequently Asked Questions
Can I change my salary mid-year?
Yes, profits fluctuate and no plan at the beginning of the year every fully materializes. As the performance of your business changes, your salary should adjust with it.
What if I only work part-time in my S-Corp?
Reasonable compensation is based on the work you actually do. If you only work 20 hours per week, your required salary would be proportionally lower than someone working full-time.
Do I have to take distributions every year?
No. You can leave profits in the company. However, S-Corp income is taxed to you personally whether you take distributions or not (pass-through taxation), so most owners distribute at least enough to cover their tax bill.
What happens if the IRS challenges my salary?
If the IRS determines your salary was unreasonably low, they can reclassify distributions as wages. You'd owe the payroll taxes that should have been paid, plus penalties and interest. This is why documentation and reasonable compensation matter.
How often should I recalculate my optimal split?
Quarterly, or whenever your business income changes significantly (25%+ increase or decrease).
Legal Disclaimer: The information provided in this article is for educational purposes only and should not be construed as tax, legal, or financial advice. Tax situations are highly individual and complex. Always consult with a qualified tax professional, CPA, or attorney before making any decisions regarding S-Corporation elections, entity structure changes, or tax planning strategies. Calculator results are estimates only and may not account for all relevant tax provisions or your specific circumstances. SCorpGuide.com and Forever Exploring LLC are not liable for any decisions made based on information provided on this site. For complete terms, see our Terms and Disclaimers.
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