She was paying herself $0 salary from her S corp.
It's a situation we see more often than you'd think. A business owner elects S corp status to save on taxes, then takes all of her money out as distributions and never runs payroll for herself. On the surface, it looks like a great deal: no payroll taxes at all.
The problem is that the IRS sees it too, and it's one of the best-known red flags for S corporations.
The rule: reasonable salary first
If you work in your S corp, you're an employee of your company. The IRS expects you to pay yourself a reasonable W-2 salary through payroll before you take distributions.
Distributions aren't subject to Social Security and Medicare taxes. That's where the S corp savings come from. But if you skip the salary entirely, the IRS can decide those distributions were really wages in disguise.
What it can cost
Here's a simple example. Say her S corp earned $160,000 in profit, and a reasonable salary for her role is $70,000.
| Example | Amount |
|---|---|
| S corp profit, all taken as distributions | $160,000 |
| Wages the IRS could reclassify | $70,000 |
| Back payroll taxes (15.3%) | about $10,700 |
That's before penalties and interest, and it can apply to every year the IRS reviews. Three years of $0 salary can turn into a five-figure bill quickly.
What else $0 salary breaks
Back taxes aren't the only issue. Skipping payroll can also cost you:
- Your health insurance deduction. For S corp owners with more than 2% ownership, health insurance premiums need to run through your W-2 to be deductible on your personal return.
- Retirement savings. You can't make 401(k) salary deferrals from distributions, and employer contributions are based on your W-2 wages.
- Social Security credits. No wages means you're not building up your own future Social Security benefits.
- Your QBI deduction. At higher incomes, the 20% qualified business income deduction can be limited by the W-2 wages your business pays. $0 in wages can mean less deduction.
What counts as "reasonable"?
There's no magic percentage. The basic question is: what would you have to pay someone else to do your job? The IRS looks at things like:
- Your duties, training and experience
- How many hours you work in the business
- What similar businesses pay for similar roles
- What you pay your other employees
- The size and profitability of the company
The fix
- Set a reasonable salary based on your role, hours and market pay.
- Run real payroll on a regular schedule, with taxes withheld, through a payroll provider.
- Catch up before year-end. If you haven't paid yourself in 2026, there's still time to adjust before your final December payroll.
- Document how you chose the number. A short memo with comparable pay data is your best defense if anyone ever asks.
- Talk to your CPA about prior years if you've gone without salary before.
An S corp still saves money when it's done right
The good news is that paying yourself a salary doesn't wipe out the benefit. Using the same example:
| Example on $160,000 profit | Amount |
|---|---|
| Self-employment tax with no S corp | about $22,600 |
| Payroll tax on a $70,000 salary | about $10,700 |
| Estimated annual savings | about $11,900 |
That's real money, and you get to keep it without worrying about what happens if the IRS takes a look. (This example leaves out state taxes and the extra costs of running an S corp, like payroll and a separate tax return.)
Is your S corp salary set right?
We'll review your pay, your distributions and your structure, and make sure you're saving taxes the right way.
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Examples are simplified for illustration and are not a guarantee of results. This article is for general information only and is not tax or legal advice for your specific situation. Tax rules change and individual circumstances vary, so please consult a qualified professional before acting.