S-Corp Salary vs. Distributions: Getting the Balance Right in 2026

The entire point of electing S-Corp status is the ability to split your income between salary and distributions. But the IRS watches this balance closely, and getting it wrong can trigger an audit, reclassification of distributions as wages, and back taxes with penalties.

How Salary vs. Distributions Work

As an S-Corp owner-employee, your salary is subject to FICA taxes (Social Security at 6.2% and Medicare at 1.45%, matched by the company). Your distributions — the profit you take after salary — are not subject to FICA.

What Is Reasonable Compensation?

The IRS considers factors including training and experience, duties and responsibilities, comparable pay for similar positions, and compensation history. For many NJ service businesses, reasonable compensation typically falls between 50% and 70% of net business income.

Common Mistakes I See

The most frequent mistake is setting salary at the minimum while taking large distributions. The IRS has successfully challenged these arrangements. Another NJ-specific mistake: forgetting that NJ treats S-Corp income differently — NJ taxes all S-Corp income at the individual level.

Getting It Right

I recommend a reasonable compensation study that documents why your salary is set where it is. A well-documented analysis of comparable wages, your role, and industry benchmarks is your best defense if questioned by the IRS.