The salary choice costing S-Corp owners $76,000

When you formed your S-Corp, someone told you: "Pay yourself a reasonable salary."

So you picked a number. Maybe $60,000. Maybe $100,000. Something that felt reasonable.

Then you forgot about it.

Your business grew. Your profit doubled. Your salary stayed the same.

That frozen number is now costing you money in one of two ways:

• Either it's too low — creating audit risk as your distributions balloon relative to your salary.
• Or it seemed "safe" at the time — but you're now overpaying payroll taxes because no one ever told you there's a more optimal split.

A business generating $300,000 in profit with a suboptimal salary leaves $25,000+ on the table. Every year.

Three years of not adjusting? That's $76,000 gone.

The fix takes one payroll adjustment and 90 minutes of analysis. And December 31st is your deadline to capture the savings for 2025.

Let me show you how to calculate your optimal salary and get it right before year-end.

Calculate YOUR Optimal Salary Right Now

Stop guessing. Here's the process:

Step 1: Find your market rate

Go to BLS.gov (Bureau of Labor Statistics). Look up your occupation and location.

Examples:

• Physical therapist in Austin: $83,000 – $89,000
• Management consultant, 10 years experience: $140,000 – $180,000
• Software developer in Denver: $121,000 – $146,000
• Marketing agency owner: $77,000 average

This is your floor. You cannot go below market rate without triggering IRS scrutiny.

Note: BLS reflects employee salaries. As a business owner performing multiple roles, you can justify higher compensation. Use these as your floor, not your ceiling.

Step 2: Validate against your total income

Many service businesses land between 30-40% of total income as salary. But this only works if it exceeds your market rate from Step 1.

• $200,000 total income → $70,000-$80,000 salary range
• $300,000 total income → $100,000-$120,000 salary range

Step 3: Compare and adjust

Your salary must be defensible based on what you'd pay someone else to do your job.

Physical therapist making $200,000 total: Step 2 suggests $70,000. But market rate is $88,000. Adjust up to $88,000-$95,000 to stay defensible.

Consultant making $300,000 total: Step 2 suggests $100,000. Market rate for an employee consultant is $105,000. You're running the business, not just consulting — $100,000-$120,000 is defensible.

Step 4: Calculate your savings

Here's the real math for a $300,000 S-Corp with $100,000 salary:

S-Corporation:

• Business Income Tax: $65,181
• Payroll Tax: $16,200
• Total Tax: $81,381

Sole Proprietorship (comparison):

• Business Income Tax: $74,514
• Self-Employment Tax: $32,306
• Total Tax: $106,820

Annual Savings: $25,439

Over five years: $127,195.

That's real money. And it's legal when done correctly.

Two Levels of Salary Optimization

Level 1: Reasonable Compensation (Everyone)

Every S-Corp owner must pay themselves a reasonable salary based on market rates. The IRS looks at:

• What employed professionals in your role earn in your geographic area
• Your training, experience, and credentials
• The duties you perform
• Industry standards

This is non-negotiable. Too low triggers audits. Too high defeats the purpose.

Level 2: QBI Optimization (High Earners)

Once your taxable income exceeds $394,600 (married filing jointly) or $197,300 (single), a different calculation enters the picture.

The Section 199A Qualified Business Income deduction allows a 20% deduction on qualified business income. For high earners, that deduction is limited by W-2 wages paid.

The optimization formula: add back all W-2 wages to net income, multiply by 2/7. That's the target for total wages to maximize QBI.

But here's the catch: If you run a Specified Service Trade or Business (SSTB), the QBI deduction phases out entirely above those thresholds.

What's an SSTB? Health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, and any business where the principal asset is the reputation or skill of employees or owners.

If you're a doctor, lawyer, accountant, or financial advisor — and your income exceeds the phase-out threshold — you may not get QBI at all. This changes the salary calculus. (See last week's email on entity structure for more on how SSTB status affects your planning.)

Three Salary Mistakes That Trigger Audits

1. Paying yourself $30K on $400K profit

The IRS has your industry data. They know market rates.

Pay yourself 25% of what comparable positions earn, and they'll reclassify your distributions as salary — retroactively.

Cost when caught: Back payroll taxes ($25,000+) plus penalties (20%+) plus interest. Total hit: $35,000+.

2. Zero salary all year, then one December paycheck

The IRS requires consistent payroll throughout the year. One $100K paycheck on December 28th after taking $300K in distributions? The IRS has successfully challenged this pattern in Tax Court.

They'll disallow the deduction, reclassify everything, and hit you with penalties.

3. Missing state-specific elections

New York requires Form CT-6. New Jersey needs CBT-2553. California has separate requirements.

Skip them? You face higher state taxes and potential double taxation. On $300,000 profit, that can cost $15,000+.

Meanwhile, Texas and Florida S-Corps pay $0 in state-level entity tax. Geography matters.

The Year-End Bonus Strategy

Most business owners pay the same salary every two weeks all year.

But if your business exceeded projections, you can optimize with a year-end bonus.

How it works:

January: You projected $200,000 profit, set salary at $70,000.

December: Actual profit came in at $280,000.

You can process a bonus payroll before December 31st to optimize the split.

• New salary: $98,000 (35% of actual $280,000)
• Bonus amount: $28,000
• Distributions: $182,000

Requirements for IRS compliance:

• Documented business purpose (performance-based, hitting revenue targets)
• Processed through payroll with time to meet federal deposit requirements (mid-December is safer than December 31st)
• Reasonable in context of total compensation and industry standards
• Proper documentation if questioned

Critical: The bonus must be paid, funds transferred, before December 31st. A board resolution dated December 30th with payment on January 5th doesn't count. S-Corps are cash basis for compensation.

This strategy is powerful for businesses with variable income. You match compensation to actual performance rather than January guesses.

The Cost of Waiting

December 31st isn't arbitrary. It's the last day you can fix 2025.

Wait until January? You can't go back and change what you paid yourself. You'll optimize 2026 going forward, but 2025's overpayment is gone forever.

Making $300,000 with a suboptimal salary costing you $2,100/month?

• Wait until January: Lose $25,400 from 2025. Gone.
• Wait until next December: $50,800 over two years.
• Wait three years: $76,300 you'll never recover.

The opportunity cost is even higher. That $25,400 invested at 7% return becomes $178,000 over 10 years.

Should You Optimize Your Salary Right Now?

Ask yourself three questions:

1. When did you last evaluate your S-Corp salary? If "when I formed the company," keep reading.
2. Has your profit changed 30%+ since you set that number? If yes, your optimal salary changed too.
3. Are you making $100K+ in S-Corp profit? Below that, optimization savings don't justify the effort.

If you answered yes to all three, you have money sitting on the table.

Still a sole proprietor? Last week's entity structure email is your starting point.

What Better Bookkeeping Does

Salary optimization isn't a one-time calculation. It requires ongoing management:

• Monthly income tracking against projections
• Quarterly salary evaluations as performance changes
• Year-end modeling to determine if bonus payroll should be processed
• Industry compensation research using BLS data the IRS accepts
• QBI deduction coordination — your salary affects your 20% deduction
• State-specific compliance so you don't trigger higher taxes or miss required elections
• Audit-defensible documentation that survives IRS scrutiny

Our year-round process:

Q1: Establish baseline salary based on prior year performance and market data. Set up payroll through Gusto or your existing service.

Q2-Q3: Monitor actual performance monthly. Model whether salary adjustments make sense. Flag opportunities.

Q4: Run comprehensive year-end analysis. Calculate optimal salary. Determine if bonus payroll should be processed. Document business purpose. Plan salary structure for next year.

Result: Clients save $15,000-$40,000 per year in unnecessary payroll taxes while staying audit-defensible.

Book Your Year-End Salary Review

If you're an S-Corp owner making $300,000+ in profit and you haven't optimized your salary in the past 12 months, book a consultation before December 10th.

We'll calculate:

• Your current salary cost vs. optimal (exact dollar overpayment)
• Industry compensation data for your specific role and location
• Whether year-end bonus payroll makes sense for 2025
• Your optimal salary structure for 2026
• How salary optimization affects your QBI deduction
• Complete documentation strategy if IRS questions your approach

We work with S-Corp owners who want to optimize rather than guess.

Fair warning: If you want this handled before year-end — while you can still affect 2025 — act this week.

Every month you delay costs $1,000-$3,000 in unnecessary taxes. Get it right once, benefit every year.

Book here

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P.S. The best time to fix your salary was when you formed your S-Corp. The second best time is right now, before year-end. After that, you're locked into 2025's mistakes and can only optimize going forward.