When is a payroll required for an S corp if I don't have one yet?

But what's considered "reasonable"? Like if the business is mostly automated or I have contractors doing most of the work, couldn't I argue that my actual time contribution is minimal? Also, how do they even track this stuff?

A reasonable salary is based on what would typically be paid to someone performing similar services in your industry and location. Even with automation and contractors, as the business owner making strategic decisions, managing those contractors, and overseeing operations, you're providing valuable services that require compensation. The IRS looks at factors like your qualifications, time spent, duties performed, and comparable pay in your industry. They don't need to "track" your time - they look at the business's profit relative to your salary. A $650k profit business with no salary or a very low one is a major red flag. Courts have consistently sided with the IRS when S corp owners take little to no salary from highly profitable businesses.

Does it actually give you a specific salary number to use? My accountant keeps saying "reasonable salary" but won't commit to an exact figure and it's driving me crazy.

I'm skeptical about these online tools. How does it know what's reasonable in your specific industry? My understanding is this is pretty subjective and depends on a ton of factors.

It doesn't just give you a single number but provides a range based on industry data for your specific role and location. It shows salary data from multiple sources so you can see what's considered reasonable in your field. My accountant was actually impressed with how comprehensive the analysis was. The tool uses industry-specific data from multiple sources, including BLS statistics and private salary databases. It's not just a generic calculator - it asks detailed questions about your business activities, time involvement, training/expertise, and geographic location. For my digital marketing business, it showed comparables for similar-sized operations and identified the specific services I perform that require compensation.

How does this actually work though? They just call the IRS for you? Couldn't I just do that myself?

Yeah right. The IRS won't even answer their phones. I've been trying for months to get someone to explain S corp salary requirements. No way some service can magically get through when millions of people can't.

They use a sophisticated system that navigates the IRS phone tree and holds your place in line. You simply enter your phone number and they call you when they've reached an agent. It's not that they have special access - they just handle the waiting game for you. Technically you could do it yourself, but you'd need to stay on hold for potentially hours. With Claimyr, you go about your day and they call you when an agent is ready to talk. I was skeptical too until I tried it - but it works exactly as advertised.

Thanks for the insight. What if my S corp is primarily generating income through digital assets that run mostly on autopilot? Would I still need to pay myself 30-40% of profits as salary even if I'm only spending maybe 5-10 hours a week actually working on it?

Even with mostly automated systems, you're still providing valuable services as the owner. You're making strategic decisions, maintaining those systems, and overseeing the business. The IRS doesn't just look at hours worked but the value you provide. That said, if you truly have minimal involvement, you might justify a somewhat lower salary percentage, but certainly not zero. Document your actual time commitment, the systems you've built, and compare to industry standards. At 5-10 hours weekly with $400-650k profit, I'd still recommend a minimum salary around $80-120k to be safe, especially if those digital assets required your expertise to create or maintain.

What payroll service do you use for your S corp? I'm at the point where I need to set one up but there are so many options.

Thanks for sharing your audit experience - that's really helpful to hear a real-world example of what happens when you don't take salary from a profitable S corp. Can you share what salary amount you ended up having to establish after the audit? I'm trying to get a sense of what the IRS actually considers "reasonable" for different profit levels. Also, did they make you pay back taxes for previous years or just going forward?

I had to establish a $75k annual salary going forward and pay back taxes for the two previous years where I should have been taking salary. The IRS calculated what they considered reasonable based on my business activities (consulting/digital marketing) and industry standards in my area. For back taxes, I owed the employer and employee portions of Social Security and Medicare taxes on what they determined should have been my salary for those years - about $85k total with penalties and interest. It was brutal. The audit took about 8 months to resolve. They looked at my business profits, the services I provided, comparable salaries in my industry, and time commitment. Even though I argued I only worked 10-15 hours per week on the business, they said the profits indicated I was providing valuable strategic oversight that warranted significant compensation. My advice: don't wait for an audit to figure this out. At your profit levels, you're definitely on their radar.

I can share what happened in my case - the IRS made me establish a $85k annual salary going forward and I had to pay back taxes for the previous two years where I took zero salary. They calculated it based on what a business consultant in my area would typically make, considering my education and the fact that I was clearly providing valuable services given the business profits. The back taxes were brutal - not just the payroll taxes I should have paid, but also penalties and interest. It ended up costing me about $45k total between back taxes, penalties, and additional accounting fees. They basically treated my distributions from those years as if they should have been partially salary. What really hurt was the 6% failure-to-deposit penalty on top of everything else. The IRS agent told me that businesses making over $250k with no payroll are almost guaranteed to get flagged for audit. Definitely don't wait like I did - the costs of compliance are way less than the costs of getting it wrong.

The IRS made me establish a $85k salary going forward and pay back taxes for the two previous years where I had taken distributions without salary. They calculated what they considered reasonable compensation based on my role (business consulting/digital marketing) and the business profits. For the back taxes, I owed about $13k in unpaid payroll taxes plus another $4k in penalties and interest. The agent explained they typically look back 3 years, but since I cooperated fully and got compliant immediately, they only assessed the most recent 2 years. The $85k salary was based on what someone with my experience would earn doing similar consulting work in my market. At $300k business profit, that worked out to about 28% as salary, which the agent said was reasonable for a service-based business. For your profit levels of $400-650k, you're probably looking at $100-180k salary range depending on your specific industry and role.

I ended up having to establish a $75k annual salary going forward, which the auditor said was reasonable for my consulting business size and industry. They made me pay back payroll taxes for the previous 3 years - essentially treating distributions I had taken as wages subject to employment taxes. The back taxes, penalties, and interest came to about $28k total. The auditor used industry salary data and looked at what similar businesses pay owner-operators. She said for a $300k profit business, anything under $60k salary would be suspect, and $75k was on the conservative side of reasonable. What really hurt was they also assessed the 20% accuracy-related penalty since I had "substantially understated" my tax liability by avoiding payroll taxes entirely. @c9b46ddd6b4b The key lesson is don't wait - once your S corp is consistently profitable, get the salary set up immediately. The IRS views taking only distributions from a profitable S corp as tax avoidance, not tax planning.

I had to establish a $85k annual salary going forward, and yes, they made me pay back taxes for the previous two years when I had taken zero salary. The IRS calculated what they considered reasonable compensation based on my industry (digital marketing consulting) and the business's profit margins. The back taxes were brutal - not just the payroll taxes I should have paid, but also penalties and interest. For my $300k profit business, they determined I should have been taking at least $80-90k in salary based on what similar consultants earn in my area. They were actually reasonable about it once I cooperated and provided documentation about my role and time commitment. The agent explained they see this constantly with S corps - owners trying to avoid payroll taxes by taking everything as distributions. The key is being able to justify your salary with industry data and documentation of your actual duties. My accountant now uses a service called taxr.ai to help determine reasonable compensation for our S corp clients. It provides industry benchmarks that the IRS recognizes as valid support for salary decisions.