Tips for Setting Low S Corporation Shareholder Salaries
The big tax savings in a small S corporation usually come
from setting the salaries of shareholder-employees to
something that's low yet reasonable. Lowering a
shareholder-employee salary by, for example, $10,000 often
saves about $1,500 in payroll taxes annually.
You need to be cautious about setting low S corporation
shareholder salaries, however. Set a salary unreasonably
low and the IRS can reclassify payments made to
shareholders as wages. That reclassification allows the IRS
to clawback tax savings and assess penalties and interest.
Fortunately, you can take employ several techniques to
reasonably lower S corporation shareholder-employee wages,
including the tips that follow:
S Corp Salary Tip #1: Use Government Data for Backup
The big requirement concerning S corporation shareholder
salaries is that the compensation be reasonable.
Reasonableness, in some ways, is in the "eye of beholder."
But a good starting point concerning reasonableness is the
Bureau of Labor Statistics web site at www.bls.gov. The
bls.gov site provides a wealth of conservative data about
what different jobs really pay.
S Corp Salary Tip #2: Learn About Any Local Safe Harbors
Another tip related to setting a low shareholder salary:
Talk with a knowledgeable local tax practitioner about the
possibility that there's an unofficial safe harbor.
Now let me be clear: Publicly, no IRS official will provide
a safe harbor amount--a salary level which, if you're over,
you're officially safe.
However, numerous tax practitioners (CPAs, attorneys, and
enrolled agents) report that in many areas, Internal
Revenue Service examiners have an unofficial salary which
they'll accept as reasonable. An S corporation which pays
its shareholder-employees at least this amount seems to be
very unlikely to be challenged or penalized...
S Corp Salary Tip #3: Treat Shareholder Health Insurance
The S corporation tax return itself makes it really easy to
spot when an S corporation pays its shareholders low
salaries: The first business deduction on page 1 of the
corporate tax return, for example, shows officer
You should, therefore, verify that you're handling
shareholder health insurance correctly. Here's why:
Shareholder health insurance gets added to the
shareholder-employee compensation amounts. If a
shareholder-employee earns, say, $30,000 in wages and in
addition receives $10,000 of health insurance, the
shareholder-employee's W-2 should show $40,000 of wages.
By the way, the health insurance amount added to the
employee's W-2 wages isn't subject to payroll taxes like
social security or medicare. Using the previous paragraph's
example numbers, the shareholder-employee's W-2 would show
the wages subject to social security and medicare taxes as
being $30,000. Furthermore, the $10,000 of health insurance
is allowed as a deduction on the shareholder's individual
S Corp Salary Tip #4: Save for Retirement Inside Corporation
Another easy idea related to setting a low yet reasonable S
corporation salary: If you're saving money for retirement,
you may as well do that saving inside the S corporation. In
other words, rather than have the shareholder-employee
contribute money into an Individual Retirement Account, the
S corporation should probably consider making a pension
fund contribution such as for a SEP-IRA. Why? The pension
contribution in this case gets treated as an expense on the
corporation's tax return.
In effect, this increases by shareholder-employee's wages
by as much as 25%. Yet this increase in wages does not
increase the payroll taxes. Current tax law doesn't subject
employee pension contributions to payroll taxes.
About the Author:
Stephen L. Nelson CPA practices public accounting in
Seattle, Washington. Nelson edits the Do-it-yourself S
Corporation web site and authored the Setting S Corporation
Salaries ebook, available at