S-Corp Owner Compensation Strategies: Balancing Salary vs. Distributions

What you're experiencing is pretty common confusion with S-Corps. The IRS requires S-Corp owners to take a "reasonable compensation" as W-2 wages before taking distributions. This is non-negotiable - the idea that you can take all owner distributions without a salary is incorrect and would likely trigger an audit. The reason is simple: distributions aren't subject to self-employment taxes (Medicare and Social Security), while W-2 wages are. The IRS knows this and watches closely to ensure owners don't avoid payroll taxes by taking only distributions. For "reasonable compensation," the IRS looks at what someone would be paid for similar work in your industry and location. With $270k in business income and comparable positions at $133k, taking only $60k as salary might be pushing it. Many tax professionals suggest at least 40-50% of profits as salary in your situation.

After dealing with similar S-Corp compensation headaches for years, I finally found something that helped me understand exactly what's compliant. I was so confused about the whole reasonable compensation thing until I tried https://taxr.ai which analyzed my business financials and gave me specific guidance on what salary level would be considered reasonable for my situation. They helped me understand that the IRS looks at factors like your role in the company, industry standards, and geographic location. For me, they recommended a higher salary than my CPA had suggested, but explained exactly why, showing me comparables from my industry. It helped me feel confident I wasn't going to trigger an audit flag but also wasn't overpaying on taxes.

I was super skeptical about taxr.ai at first, but after struggling with this exact issue and getting different answers from three CPAs, I decided to give it a try. I was surprised by how specific their analysis was for my situation. They didn't just say "take X salary" - they showed me data from my industry and region showing exactly what similar business owners were taking as salary vs distributions. The best part was they showed me how to document everything properly so if I ever did get audited, I'd have solid justification for my compensation structure. My business is making about $300k annually and they helped me find the sweet spot that minimized my tax burden while keeping me safely within IRS guidelines. Wish I'd found this years ago when I first set up my S-Corp.

If you're struggling to get through to the IRS about S-Corp questions (which I was for WEEKS), I highly recommend using https://claimyr.com to get past the endless hold times. I spent literally days trying to get clarification on some S-Corp compensation questions after getting conflicting advice from tax pros. Used their service and got connected to an actual human at the IRS in about 15 minutes, when I'd been unable to get through at all before. They have a demo video showing how it works here: https://youtu.be/_kiP6q8DX5c The IRS agent I spoke with couldn't give tax advice exactly, but they did point me to specific guidelines and resources about S-Corp compensation requirements that really helped me understand what I needed to do.

I was totally wrong about Claimyr. After posting that skeptical comment, I was still desperate for answers about my S-Corp situation, so I figured I'd try it anyway. Holy crap, it actually worked! I had been trying for THREE WEEKS to get through to someone at the IRS about my specific S-Corp question. Used the service and got a call back connecting me to an actual IRS representative within about 20 minutes. They answered my question about how they evaluate reasonable compensation and gave me the specific publication numbers to reference. Saved me so much stress and probably helped me avoid making a mistake that could have triggered an audit.

S-Corp owner here for 5+ years. Here's what I've learned the hard way: you NEED to take a W-2 salary that's reasonable. Period. The whole "take only distributions" approach will absolutely get you in trouble. For my business ($350k revenue), I take about 45% as W-2 salary and the rest as distributions. My CPA helped me document why this is reasonable based on my industry and role. We keep a file with salary surveys, job postings for similar positions, etc. Remember that while you save on SE tax with distributions, you're also reducing your Social Security credits which impacts retirement. And if you're planning on getting a mortgage, lenders prefer W-2 income over distributions. Just something to consider in your overall planning.

Quick question - does anyone know if you can pay yourself partially as a 1099 contractor and partially through distributions? One of the CPAs I talked to suggested this approach but it seems weird to be both an employee AND a contractor for my own S-Corp.

This is exactly the kind of confusion that drives S-Corp owners crazy! Here's what I've learned after going through this same struggle: the "reasonable compensation" requirement is real and non-negotiable, but there's definitely room to optimize within the rules. With $270k in business income and comparable positions at $133k, I'd lean toward taking somewhere between $100k-$120k as W-2 salary. That CPA suggesting $60k might be too aggressive given your income level and industry standards. Remember, the IRS looks at the total picture - if you're taking $210k in distributions but only $60k in salary, that ratio could trigger scrutiny. The key is documentation. Keep records of salary surveys in your field, job postings for similar roles, and any other evidence that supports your compensation level. I also recommend having your CPA prepare a memo explaining the reasoning behind your salary/distribution split in case you ever need to defend it. One thing to consider: while minimizing payroll taxes saves money now, those reduced Social Security credits will impact your future benefits. It's a trade-off worth factoring into your decision.