Every S-corp owner faces the same question: how much should I pay myself in W-2 wages versus taking the rest as distributions? Get it wrong, and you're either leaving money on the table or inviting an IRS audit. I see owners miss this by $50,000 or more every year—sometimes in both directions.
The basics (because your buddy at the golf course got this wrong)
S-corp distributions aren't subject to self-employment tax. W-2 wages are subject to payroll taxes. So the instinct is to minimize wages and maximize distributions.
Here's the problem: the IRS requires you to pay yourself "reasonable compensation" before taking distributions. There's no bright-line test for what's reasonable, but there are factors they look at—your role, the hours you work, what similar positions pay in your market, and how much revenue the business generates.
A $2 million revenue construction company owner paying himself $40,000 in W-2 wages? That's going to draw scrutiny. The IRS knows a project manager at a similar company makes $90,000+, and you're doing that job plus running the business.
The math that matters
Let's say you're trying to decide between $80,000 and $150,000 in W-2 wages, with the rest coming as distributions.
At $80,000 in wages, you're paying roughly $12,240 in combined payroll taxes (employer and employee share of Social Security and Medicare). Everything above that comes out as distributions with no additional payroll tax.
At $150,000 in wages, you're paying roughly $17,685 in payroll taxes. That's about $5,445 more per year.
So you should go with $80,000, right? Not necessarily.
Here's what gets missed: W-2 wages affect your qualified business income (QBI) deduction, your ability to contribute to retirement accounts, and your Social Security benefits down the road. A $150,000 salary lets you contribute up to $69,000 to a solo 401(k) in 2024 (with catch-up contributions if you're over 50). An $80,000 salary maxes out around $46,000.
That extra $23,000 in retirement contributions at a 32% marginal rate saves you $7,360 in income taxes—which more than offsets the additional payroll tax.
Where owners actually get burned
The real damage happens in two scenarios:
Scenario 1: Salary too low, audit risk too high. I worked with an oilfield services owner who'd been paying himself $48,000 for five years while the company did $3-4 million in revenue. His accountant never pushed back. When he went to sell the business, the buyer's diligence team flagged it immediately. The buyer adjusted EBITDA down by $120,000 annually to reflect "normalized" owner compensation—which cut his sale price by nearly $500,000.
Scenario 2: Salary set and forgotten. Your reasonable compensation changes as your business grows. The right salary when you're doing $800,000 in revenue isn't the right salary at $2.5 million. Most owners set their W-2 wages once and never revisit it. Five years later, they're either overpaying taxes or sitting on audit risk they don't even know about.
The framework I use with clients
Start with market data. What would you pay someone to do your job—not as an owner, but as an employee? Use salary surveys, job postings, and industry benchmarks. For most owner-operators in construction, manufacturing, or energy services, this lands between $100,000 and $200,000 depending on company size and complexity.
Then layer in the tax planning. How much do you want to contribute to retirement accounts? Are you maximizing the QBI deduction? What's your overall marginal rate?
The target isn't "lowest possible salary." The target is the salary that minimizes your total tax burden while keeping you defensible with the IRS. Those aren't always the same number.
Where to start
Pull your W-2 from last year and your Schedule K-1. Compare your wages to what a similar role pays in your market—spend 15 minutes on Indeed or LinkedIn for your area. If there's a gap of more than 20%, it's worth a conversation with someone who can run the full analysis.
At Laverton Advisory, this is one of the first things I look at with new clients. It's not glamorous work, but it's often worth $10,000-20,000 per year in tax savings or risk reduction.
Derek Hammock is a CPA and fractional CFO at Laverton Advisory. He works with founder-led businesses to build the financial clarity they need to make better decisions.