How much should you pay yourself as an S-Corporation owner?

As a business owner, you have more options for setting your own income. But as with everything about owning your own business, there are many factors to consider when cutting yourself that paycheck.

Why S-Corporation owner pay matters

When you own an S-Corporation, your business income is divided into two parts: salary/w2 wages and distribution.

The most significant tax advantage of an S-Corp is that Social Security and Medicare taxes are only paid on the salary portion of your business income.

Social Security and Medicare tax add up to 15.3% until you reach the SS wage limit ($168,600 in 2024 and $176,100 in 2025). Half of it can be deducted, which means the effective rate is 14.13%.

As you can imagine, this amounts to a lot (over $20,000 if you have a salary of $150k).

Compare this to being taxed as a sole proprietor, where you would pay self-employment tax (essentially the equivalent) on the entire income.

The name of the game for saving on Social Security and Medicare taxes is creating separation between your S-Corp’s total income and the salary you pay yourself.

This really matters if you can justify paying yourself a salary less than the Social Security wage limit.

Deciding how much to pay yourself

Obviously, the lower your salary, the less you will pay in Social Security and Medicare taxes. But how low can you go?

Unfortunately, the IRS is very vague, only saying you need to pay yourself a “reasonable salary.” 

So, what does that mean? It means choosing a number you can justify to the IRS.

Estimate the value of all your work

If you are an employee, you likely spend most, if not all, of your time, practicing the specialized craft in which you trained for years.

However, most business owners spend at least some time as bookkeepers, payroll clerks, administrative assistants, or even custodians/janitors (unless you have hired for these roles). If you are part-time, you can adjust the amount you pay yourself to reflect this.

The best way to ensure this is to pay yourself a market rate that reflects your skills and duties as a business owner.

Here is how it looks: you would write down all your roles as a business owner and document how much time you spend in each role. This is also called the “all hats” approach.

Find the mean wage for each work task

You can look up the market rates for each of these roles using data from the Bureau of Labor Statistics or another source. Ideally, you will also be able to enter your region or zip code to see what the rates are locally.

I like that you can search every state for various occupations, and I trust that the data is reliable.

What I don’t like as much is that it only shows the mean wage and not other percentiles. You might have good reason to pay yourself a higher or lower percentile based on your proficiency, experience, and the type of patients or clients you work with.

Find the wage range for each work task

You can also use a database from another source, such as Zip Recruiter or Monster, to estimate the value of your work responsibilities.

I like these sites because they show percentiles, and you can choose which percentile is most appropriate.

What I don’t like is that there is a lot of variation in the numbers each site uses (when I checked, Zip Recruiter had higher numbers for a few professions than Monster, but this was quite a bit lower than the mean BLS salary).

Any of these sources is fine, but it’s best to document where you obtained your data in case your salary is questioned.

How to estimate your wage: An example

Walter White is a high school teacher who freelances as a chemist. He forms an S-Corporation for his chemist business. He is located in Albuquerque, NM (and because this is a community property state, his wife, Skylar, must consent to the S-Corporation election).

He reports $100,000 in profit for his business for 2024 and does not tell his accountant about the millions he hides in a storage center. He sees that the average chemist in Albuquerque makes $62,488 (using info from Zip Recruiter).

He also reports that he only spends 85% of his business time as a chemist; he also estimates he spends 5% of his time as a “manager” (average salary $43,000 per year), 5% of his time as a custodian ($32,000 per year), and 5% of his time as a laundry attendant ($15 per hour, or $30,000 per year).

He comes up with the following blended full-time salary:
$62,488 x 85% = $53,115

$43,000 x 5% = $2,150

$32,000 x 5% = $1,600

$30,000 x 5 % = $1,500
Total = $58,365

He also reports that he only works 70% of a full-time schedule, so he applies a part-time adjustment of $58,365 x 70% = $40,856. He documents these calculations in case he is ever audited.

As a result, he pays himself $40,856 in salary, and the remaining $59,144 is a distribution. Social Security and Medicare tax is only paid on the salary.

If he were not an S-Corporation, he would pay an extra $8,000+ in self-employment taxes. When the DEA raids his storage units, he will still go to prison for tax evasion and other charges, but at least he will save on self-employment tax ($8,000 goes a long way at the commissary!).

This works much better for a chemist than for a traditionally higher-paying job (dentist, physician, etc.). However, it can still be advantageous if the business is profitable (in other words, you make quite a bit more money than you would as an employee doing the same work).

Other Ways to Calculate Salary

Another salary calculation option is to use a flat percentage of income as salary. This is a much less rigorous approach than one that relies on market data, and for that reason, it is less likely to stand up in the event of an audit.

There are other ways, such as comparing salary to the business’ valuation using discounted cash flow, which are more complex.

One silver lining is that your compensation can include items not subject to Social Security and Medicare taxes. Top among these are health insurance and HSA contributions, which are treated as compensation for S-Corp owners.

These are added to Box 1 of the W2, but not Box 3 or 5 (SS and Medicare taxed income). I have worked with clients who pay over $30,000 yearly for health insurance, and the limit for family HSA contributions is now over $8,000 annually.

Why the lowest possible salary may not be the best option for you

There are also some very good reasons you might not want the lowest possible salary. These include:

• Social Security taxes you pay now result in higher SS benefits later. This is somewhat nuanced, but conceptually, you get a higher return on investment on SS contributions if your lifetime SS income is low. If you are a high earner over your career, the return goes down significantly.
• You can only make (solo) 401k contributions based on your wages, not distributions.
• Taxpayers who earn over a certain amount of income have their QBI deduction reduced if their wages do not exceed a certain threshold. This is complex and challenging to model, but it can be done using a spreadsheet or tax software.

Generally, if you are an S-Corp officer, there is some risk in not paying yourself a sufficient salary, but the risk of an audit for a high salary is negligible.

That’s all for now! If you aren’t sure how much to pay yourself in salary for 2024 or 2025, feel welcome to schedule a meeting if you're already an SLP Tax client, or if not, schedule an introductory call here to become a client.