Why Reasonable Salary Matters (in Dollars)

When your S corporation pays you W-2 wages, both you and the business pay Social Security and Medicare taxes. On each $10,000 of salary:

• Employee side: 7.65% (6.2% Social Security + 1.45% Medicare)
• Employer side: 7.65% again

That's 15.3% total payroll tax, or $1,530 on every $10,000 of wages (on top of income tax).

Example: If $80,000 would be a defensible salary but you pay yourself $90,000 instead, that extra $10,000 costs about $1,530 in additional payroll taxes. Even a $5,000 difference costs about $765.

That's why we care about making your salary reasonable, not generous.

Practical Starting Points for a Reasonable S Corp Salary

1. The "1/3, 1/3, 1/3" concept

A common rule of thumb for many service businesses (consultants, attorneys, tax and accounting professionals, therapists, etc.) is that revenue roughly breaks into three parts:

• 1/3 salary (what it costs to pay the owner for their work)
• 1/3 operating expenses
• 1/3 profit / owner distributions

This is not a law, but it's a useful starting point. From there, we adjust up or down based on:

• Actual expenses and how lean your operation is
• Your role (do you still do everything, or do you have a team?)
• Goals like maximizing retirement contributions

2. Labor data and your peers

Tools like Bureau of Labor Statistics data, industry salary surveys, and RCReports can show what people in similar roles typically earn. That doesn't mean your salary must exactly match the median:

• You might work part-time instead of full-time.
• Your business model may be more efficient or more niche.
• Your practice may be early-stage, or your revenues may be unusually high relative to hours worked.

The key is being able to say, "Here's the benchmark, and here's why I'm higher or lower."

3. Your salary doesn't have to grow dollar-for-dollar with profit

Once you've established a reasonable salary tied to your role, it doesn't automatically double just because your profit doubles. Judges and agents do look at your net income and distributions, but your salary is still anchored to:

• What your work is worth in the marketplace, and
• How much of your company's income is tied to systems, team, or past work (enterprise value) rather than just your current hours.

It's common for large employers to have labor burden rates of 1.4--2.0 times your base pay. That means a $100,000 employee can cost the company $140,000--$200,000. As a lean small business owner with more risk and fewer layers of overhead, a somewhat lower W-2 salary can still be very defensible.

Ready to Set a Smart, Defensible S Corp Salary?

If you are an S corporation owner wondering what to pay yourself -- or you suspect your current salary may be too high or too low -- we can help you dial it in.

• Review your current salary, profit, and distributions
• Use RCReports and industry data to anchor a reasonable range
• Build a payroll plan that fits your cash flow and tax goals