Are You Paying Yourself Correctly as a Business Owner?

What S-Corp Owners in Western North Carolina Need to Know

If you own a business structured as an S-Corporation, one of the most important tax decisions you make every year has nothing to do with deductions or deadlines. It's about how you pay yourself. And getting it wrong can cost you, either in unnecessary taxes or an unwanted conversation with the IRS.

This is one of the most common issues we see with small business owners in Franklin and across Western North Carolina. It doesn't get talked about enough.

Why This Matters

S-Corporations come with a real tax advantage. As an owner, you can split your business income into two buckets: a W-2 salary and owner distributions. Only your salary is subject to self-employment taxes. Distributions are not. For profitable businesses, that difference can add up to meaningful savings every year.

But the IRS knows about this advantage, too. S-Corp owner-employees are required to pay themselves a salary that reflects fair market value before taking any distributions. Owners who pay themselves too little, taking most of their income as distributions to sidestep payroll taxes, are a consistent IRS audit target. This isn't a gray area. The IRS actively looks for it.

What Is a "Reasonable Salary"?

The IRS defines reasonable compensation as what you would pay an unrelated employee to do the same job in a similar business. There is no magic number and no fixed formula. Every situation is evaluated on its own facts, including things like your role and responsibilities, how profitable the business is, what comparable employees earn in your industry and region, and how much of the business income comes from your personal services versus your employees, systems, or capital.

There are a few common approaches business owners use to land on a defensible number. Some compare their role to market pay data for similar positions. Others break their responsibilities into specific functions and assign a rate to each. Some look at what they earned doing similar work before they owned the business. Most CPAs recommend using more than one method and documenting your reasoning.

That last part matters more than people realize. If the IRS ever questions your salary, having a paper trail showing you thought it through carefully goes a long way.

What Happens If You Get It Wrong?

The consequences go both ways.

Pay yourself too little, and the IRS can reclassify your distributions as wages. That means back payroll taxes, interest, and potentially significant penalties on top of that. Federal courts have consistently sided with the IRS in these cases, and the outcomes are expensive and avoidable.

Pay yourself too much, and you wipe out the tax advantage that made the S-Corp structure worth it in the first place.

It Is More Than Just a Payroll Decision

Your salary also affects other parts of your tax picture, including certain deductions that phase in or out based on your income and wage levels. The right number is not just about staying off the IRS radar. It is about finding the compensation level that makes the most sense across your entire return. And that calculation is worth revisiting regularly, especially as your business grows or your role changes over time.

So What Should You Do?

If you have not reviewed your owner compensation in a while, mid-year is actually a great time to look at it. There is still time to make adjustments before year-end if something needs to change.

Start by researching what comparable roles pay in your industry. Write down your reasoning. And before you make any changes, talk to your CPA. Adjusting your salary has payroll and tax implications that need to be handled carefully and coordinated with your overall tax strategy.

Questions About Your Business Tax Strategy?

At Denise Stubbs CPA, we work with small business owners across Franklin and Western North Carolina to make sure their tax strategy is actually working in their favor. If you want to take a closer look at your compensation structure or your overall tax picture, we would love to help.

Call us at 828-570-5760.

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This blog post is provided for educational purposes only and does not constitute personalized financial, tax, or investment advice. Tax laws are complex, change frequently, and vary based on individual circumstances. Before implementing any strategies discussed, please consult with qualified financial advisors, tax professionals, or CPAs who can assess your specific situation. This content should not be relied upon as a substitute for professional consultation.