You have probably heard the rule: pay yourself 60 percent as salary, take 40 percent as distributions, and the IRS leaves you alone. It gets repeated in owner groups, on YouTube, and sometimes by accountants who should know better.

It is not a rule. No percentage split appears in the tax code, in IRS guidance, or in any court decision. The IRS has never approved a fraction. What it requires is something less convenient to remember and more important to get right.

What the IRS actually requires

An S-corp shareholder who works in the business must pay themselves reasonable compensation as W-2 wages, through payroll, before taking distributions. Reasonable is measured against the work performed and what that role would command at arm’s length. It is not measured against a tidy share of profit.

The reason owners push salary down is real. Distributions avoid the payroll taxes that wages carry. For 2026, that is 12.4 percent Social Security on wages up to the $184,500 wage base, plus 2.9 percent Medicare with no cap, plus an extra 0.9 percent Medicare above $200,000 single or $250,000 joint. Move a dollar from salary to distribution and you save those taxes on that dollar. That is the legitimate benefit of the S-corp election, and the exact temptation to take it too far.

What happens when the salary is too low

When compensation is unreasonably low, the IRS does not disallow the structure. It reclassifies distributions as wages, then assesses the back payroll tax, plus penalties and interest, often across several open years at once. The savings reverse, and then some.

The leading example is the Watson case, where a CPA paid himself a modest salary while taking far larger distributions from his firm. The IRS recharacterized a substantial share of those distributions as wages, and the courts upheld it. The split that felt safe was not, because it was never tied to what the work was worth.

What “reasonable” actually weighs

There is no formula, but the factors are well established:

• Training, experience, and the duties you actually perform
• Time and effort devoted to the business
• What comparable businesses pay for similar work
• How much of the profit comes from your labor versus from employees, capital, or other owners

That last factor is the one most owners miss. If the business’s profit is essentially your own billable work, you cannot justify a token salary. If employees and capital generate profit beyond your personal labor, you have more room.

Same election, different defensible numbers

A DC federal contractor consulting through an S-corp and billing $280,000 a year that is almost entirely their own work cannot defend a $50,000 salary. The profit is the labor. A Rockville medical practice with associates, staff, and equipment driving part of the profit can defend a different split, because not all the profit traces to the owner.

Same election, different facts, different defensible compensation. The percentage someone quoted you came from a business that was not yours.

What to do instead

Set salary from a defensible compensation analysis, document the basis, run real payroll, and revisit it when income or duties change. The goal is not the lowest number that escapes notice. It is the right number you can defend if asked.

This is one piece of the larger structure question covered in our overview of tax planning for high-income earners, and it is part of what strategic tax planning is built to handle.

Want this reviewed against your own numbers? Schedule a discovery call at intake.simonsgroup.net to start a focused conversation.

Frequently asked questions

Is there an IRS-approved salary percentage for S-corps?

No. There is no 60/40 rule or any other approved split. The standard is reasonable compensation for the work performed, judged on the facts.

What happens if my S-corp salary is too low?

The IRS can reclassify distributions as wages and assess back payroll tax, penalties, and interest, often across multiple years. The intended savings reverse.

How do I set a reasonable salary?

Base it on a compensation analysis: your role, duties, time, market pay for similar work, and how much profit comes from your labor versus other sources. Document it and revisit as the business changes.