Can I pay myself a $30,000 salary if my S corp makes $200,000?

Not defensibly, unless $30,000 is close to what your work is actually worth. Rev. Rul. 74-44 lets the IRS recharacterize distributions as wages when they are paid in place of reasonable compensation, and in Watson the courts moved a $24,000 salary to $91,044 for a CPA taking roughly $200,000 of distributions. Losing that argument costs the employment tax plus interest and penalties, so set the salary against comparable pay data and keep the documentation.

Does an S corp lower my income tax or just self-employment tax?

Just self-employment tax, and it usually raises income tax a little. Wages are not qualified business income, so the §199A deduction shrinks by 20% of every dollar you pay yourself in salary. In the $120,000 example above, the election saved $6,245 of payroll tax and added $2,922 of income tax, which nets to $3,323.

Will a low S corp salary trigger an audit?

Officer compensation is a named IRS exam issue, and the pattern that draws attention is large distributions paired with little or no wages. IRS Fact Sheet 2008-25 lists the factors used to test the salary: training and experience, duties and responsibilities, time devoted to the business, what comparable businesses pay for similar services, and dividend history. A salary that is most of a modest profit rarely raises an eyebrow. A $24,000 salary on $200,000 of distributions is the Watson fact pattern.

Do I have to form a corporation, or can my LLC be taxed as an S corp?

Your LLC can elect it. File Form 2553 and the LLC keeps its state law identity while being taxed as an S corporation, which is what most one-person S corps actually are. The election is due two months and 15 days after the start of the tax year it applies to, and Rev. Proc. 2013-30 grants relief up to three years and 75 days late when you have reasonable cause for missing it.

What if I elect S corp status and the numbers do not work out?

You can revoke the election with a statement under §1362(d)(1), but §1362(g) then generally bars a new election for five tax years without the IRS's consent. That five-year door is the reason to run the arithmetic before filing Form 2553 rather than after. Nothing is lost by staying a sole proprietor another year while the profit grows into the election.

The Journal / Business Tax

When Is an S Corp Worth It? The Profit Number That Actually Matters.

By Ewan Morkel, EASeptember 24, 20266 min read

An S corporation saves self-employment tax only on the profit above a reasonable salary. At $120,000 of profit the 2026 federal saving is $3,323, and payroll plus a second return takes most of it.

Illustration of a payroll sheet beside a folder and two pencils

A freelance developer clears $120,000 after expenses, mentions it over dinner, and hears the sentence every profitable sole proprietor eventually hears: you need an S corp. The rule of thumb that comes with it is usually $40,000 or $60,000 of profit, and it is the wrong test. When an S corp is worth it has almost nothing to do with what you gross and everything to do with the gap between your profit and what your own work is worth as a salary.

The mechanism

The election saves payroll tax, and only payroll tax.

A sole proprietor or a single-member LLC pays self-employment tax on 92.35% of net profit. That is 12.4% for Social Security up to the 2026 wage base of $184,500, 2.9% for Medicare with no ceiling at all, and another 0.9% on earnings above $200,000 single or $250,000 joint. On $120,000 of profit, that is $16,955 before a dollar of income tax.

An S corporation splits the same profit in two. The salary it pays you is W-2 wages and carries the full 15.3%, half withheld from your check and half paid by the company. The rest passes through on a Schedule K-1 as ordinary income, and Rev. Rul. 59-221 holds that a shareholder's pro rata share is not net earnings from self-employment. Income tax applies to it. Social Security and Medicare do not.

The salary

You do not get to pick the salary.

This is where the strategy dies for people who treat the salary as a dial. Rev. Rul. 74-44 dealt with two shareholders who drew no salary and took dividends equal to what reasonable compensation would have been. The IRS treated the payments as wages subject to FICA, FUTA, and withholding, and that holding is still the backbone of every reasonable compensation exam. In David E. Watson, P.C. v. United States, 668 F.3d 1008 (8th Cir. 2012), a CPA paid himself $24,000 while his S corp distributed $203,651 to him in 2002 and $175,470 in 2003. The government's valuation expert put his services at $91,044 a year, the district court adopted that figure, and the Eighth Circuit affirmed it.

So the salary is whatever someone would have to pay a stranger to do your job, and the saving lives above it. How far that line has been pushed is its own story, which I told in the S corp Medicare tax loophole. If your profit is roughly what your labor is worth, there is no room and no election to make.

The math

When an S corp is worth it, in one table.

Here is the whole decision for a one-person service business, run both ways on the same $120,000 of profit.

One-person service business, $120,000 of profit, single filer, tax year 2026

Self-employment tax as a sole proprietor: $16,955
Federal income tax as a sole proprietor: $11,506
Total federal tax as a sole proprietor: $28,461
Payroll tax on a $70,000 S corp salary: $10,710
Federal income tax with the S corp: $14,428
Total federal tax as an S corp: $25,138
Tax saved by the election: $3,323
Payroll service and a separate Form 1120-S: ($1,500 to $3,000)
What is actually left: $323 to $1,823

2026 tax year, federal only, single filer with no other income and the $16,100 standard deduction. Self-employment tax is 15.3% on 92.35% of profit, all of it under the $184,500 Social Security wage base. The sole proprietor's §199A deduction is capped at 20% of taxable income before the deduction, $19,084, rather than 20% of the $111,522 of qualified business income. The S corp column assumes $70,000 of W-2 wages, $5,355 of employer FICA deducted by the corporation, and $44,645 of K-1 income, which produces an $8,929 §199A deduction. No state income tax, no state entity fee, and no retirement plan contributions.

Three thousand dollars is real money, and it is also most of what a payroll service and a second tax return cost. That is the honest answer at $120,000: roughly break-even, worth doing for someone who was going to formalize the books anyway, not worth the paperwork for someone who wants to be left alone. Move the profit to $200,000 against a $90,000 salary and the saving is about $9,500, which is a different conversation.

The catch

The QBI deduction takes back part of the saving.

Section 199A gives you 20% of qualified business income, and wages are not qualified business income. Neither is the employer half of the FICA paid on them. The sole proprietor above had $111,522 of QBI. The same business as an S corp had $44,645, because $70,000 of it went out as salary. That is why the $6,245 of payroll tax the election saved came out to $3,323 once income tax was recomputed: the salary that escapes payroll tax also shrinks the deduction on the other side of the return.

Above the §199A threshold, which Rev. Proc. 2025-32 sets at $201,750 of taxable income for a single filer and $403,500 for a joint return in 2026, the incentive inverts. The deduction gets capped at the greater of 50% of the W-2 wages the business paid or 25% of those wages plus 2.5% of the unadjusted basis of its property, so at that income a low salary can cost more deduction than the payroll tax it saves. The phase-out ranges are in my post on the QBI deduction at high incomes.

The cost

Payroll, a second return, and a five-year door.

Budget $500 to $1,200 a year for a payroll service and $1,000 to $2,500 for the Form 1120-S, plus quarterly Forms 941, a W-2 every January, and a state withholding and unemployment account. Miss the March 15 due date on the 1120-S and §6699 charges $260 per shareholder per month for up to 12 months, the amount Rev. Proc. 2025-32 sets for returns required to be filed in 2027, and it applies even though the corporation itself owes no tax. Some states charge for the privilege on top of that: California collects the greater of $800 or 1.5% of net income every year. Utah does not.

Two more items belong in the column. A low salary shrinks the retirement plan, because the employer contribution to a solo 401(k) is capped at 25% of W-2 wages inside an S corp instead of roughly 20% of net earnings for a sole proprietor. And the election is not a season pass: revoke it and §1362(g) generally bars a new election for five years without the IRS consenting. The election itself is Form 2553, due two months and 15 days into the tax year it applies to, with late relief available under Rev. Proc. 2013-30.