What to pay yourself, and why the arithmetic changed

Ask most owners of an S corporation how they set their own salary and you will get some version of the same answer: low enough to keep the payroll tax down, high enough that nobody asks questions.

That instinct was never quite right. As of this year it is, for a meaningful number of owners, expensive.

The rule, and what is not in it

An S corporation pays no federal income tax itself. Profit passes to the owner’s personal return. Where the owner also works in the business, the code requires them to be paid a reasonable salary for that work, and that salary carries payroll tax. Whatever is left can be taken as a distribution, which does not.

So the incentive is obvious and the arithmetic looks simple. Every dollar moved from salary to distribution saves the payroll tax on that dollar.

What is not in the rule is a number. There is no percentage, no formula, no safe threshold. The statute asks for a reasonable allowance for services actually rendered, and the meaning of reasonable has been settled case by case rather than by regulation. Anyone who tells you sixty percent, or a flat forty thousand, is quoting a rule of thumb that has never appeared in the code.

What an examiner actually weighs

Having sat on that side of it, the factors are less mysterious than the absence of a formula suggests. An examiner is building a picture of what the work is worth, and the picture comes from ordinary things:

What you do all day. Duties, hours, and whether you are running the business or holding a title while others run it.

What your training is worth. Qualifications, licences, years in the field, and what the market pays somebody with them.

What comparable roles pay. Not what the business can afford. What the job is worth to somebody else.

What everyone else in the business earns. A company paying its staff market rates while the owner takes a token salary and large distributions is telling a story about itself.

What the distributions look like. Regular payments in even amounts, taken on a schedule, tend to look like wages wearing a different name.

None of these is decisive on its own. Together they are how a salary gets tested, and the outcome when a salary is found unreasonably low is reclassification: distributions become wages, with payroll tax, interest and often penalties attached.

The part that changed

Here is what makes this year different, and it is the part most owners have not absorbed.

The qualified business income deduction under section 199A lets owners of pass through businesses deduct up to twenty percent of qualified business income. The One Big Beautiful Bill Act, signed on 4 July 2025, made that deduction permanent at section 70105, removing the sunset that had been scheduled for the end of 2025. The same act widened the phase in ranges, from fifty and one hundred thousand dollars to seventy five and one hundred and fifty thousand, and added a new minimum deduction at section 199A(i) of four hundred dollars for taxpayers with at least a thousand dollars of qualified business income from an active business. Both figures are inflation adjusted for tax years after 2026, and both apply from tax years beginning after 31 December 2025.

Two mechanics inside that deduction bear directly on what you pay yourself.

Your salary is not qualified business income. Under section 199A(c), reasonable compensation paid to a shareholder employee is deductible to the company but specifically excluded from qualified business income. Every dollar of salary is a dollar that cannot attract the twenty percent deduction.

Above a threshold, the deduction is capped by your salary. Once taxable income passes the threshold, the deduction is limited to the greater of fifty percent of the W-2 wages the business pays, or twenty five percent of those wages plus two and a half percent of the unadjusted basis immediately after acquisition of qualified property.

For 2026, Revenue Procedure 2025-32 sets those thresholds at $201,750 for a single filer, head of household or qualifying surviving spouse, $201,775 for married filing separately, and $403,500 for a married couple filing jointly.

Why that flips the answer

Read those two together and the strategy inverts depending on which side of the threshold you sit.

Below the threshold, no wage test applies at all. The deduction is available without reference to what the business pays in wages. Salary still reduces qualified business income, so the traditional instinct holds: a lower reasonable salary generally leaves more on the table for the deduction and saves payroll tax as well. Both effects point the same way.

Above the threshold, they point in opposite directions. The deduction is now capped at half your W-2 wages. Cut the salary and you cut the cap. An owner who trims their salary to save payroll tax can lose more in forfeited deduction than they saved, and the loss is invisible unless somebody models it.

That is the whole point. The right salary is not the lowest defensible one. It is the one where the payroll tax saved and the deduction preserved are balanced against each other, and where that balance sits depends on your taxable income, your profit, your filing status and whether the business owns qualified property.

There is a further wrinkle for professional practices. Specified service businesses, which include law, accounting, medicine and consulting, lose the deduction entirely across a phase out band above the threshold. For those owners, moving taxable income back below the threshold can be worth more than any adjustment to salary, and retirement contributions are usually the lever that does it.

What this means in practice

If your taxable income is comfortably below the threshold, the old logic still applies and the job is simply to have a salary you can defend.

If you are near or above it, the number needs modelling rather than guessing, and it needs modelling before the year closes. Payroll for a year already run cannot be rewritten in April.

If you have never documented how your salary was arrived at, that is the gap worth closing first. A reasonable salary supported by a comparability study, a note of your duties and hours, and a record of the reasoning is a position that holds. The same number with nothing behind it is an assertion.

If you have been taking distributions and no salary at all, that is the one version of this with no defensible reading, and it is the fastest way to turn a planning question into an examination.

The rule has always been that the salary must be reasonable. What changed is that unreasonably low now costs you twice.

Sources

• Internal Revenue Code section 199A, qualified business income
• Internal Revenue Code section 162(a)(1), reasonable allowance for salaries
• One Big Beautiful Bill Act, section 70105, enacted 4 July 2025
• Revenue Procedure 2025-32, inflation adjusted figures for 2026
• IRS Forms 8995 and 8995-A and their instructions

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This article is general information and not advice about your situation. No CPA client relationship is created by reading it.