If you’re running your business as an LLC or sole proprietorship in 2025, your tax bill could be thousands higher than it should be, and you’d never know just by looking at your tax return.
Most profitable business owners pay double the tax on their earnings—up to 15.3% more—by ignoring the one IRS-approved move that could save them $10,000–$20,000 per year: switching to an S Corporation and splitting their income.
The scare factor? It’s completely legal, and the IRS has signaled a crackdown only when owners get greedy or sloppy. Here’s how real S Corp strategy works—without triggering an audit.
Quick Answer: Is the S Corp Salary Split Worth It for You?
S Corp owners can save thousands by splitting business profits into two buckets: a ‘reasonable salary’ (paid via payroll and subject to self-employment tax) and the rest as a tax-advantaged distribution (only subject to income tax, not Social Security/Medicare).
If you earn $100,000 and pay yourself a $50,000 salary, you could save $7,650–$12,000 in self-employment taxes each year through this strategy. But salary must be reasonable, and documentation is king.
Slicing Up Self-Employment Tax: Why Your LLC Leaves Money on the Table
The trap: LLC owners pay the full 15.3% self-employment tax (Social Security and Medicare) on all business net profit. Say you net $120,000—your tax hit is $18,360 on top of income tax. S Corp structure lets you split that income:
- • Salary: $70,000 (subject to payroll/self-employment tax)
- • Distribution: $50,000 (not subject to payroll/self-employment tax)
The math? At 15.3%, that’s $7,650 tax on your distribution avoidance. Repeat yearly and you’re $30K+ richer every 3 years—all without a single new deduction.
Will the S Corp Salary Split Work for My Business?
If you’re making more than $50,000 in profit, an S Corp salary split almost always creates net tax savings. Contractors (1099), solo LLCs, professional services, and even consultants with “lumpy” income are in the sweet spot. Pocket more by year-end—legally.
Step-by-Step: Pulling Off the S Corp Salary Split Without an Audit
- Elect S Corp Taxation: Use IRS Form 2553—get this in early (March 15 for retroactive year coverage).
- Open Payroll: Set up a W-2 payroll—either DIY or with a provider.
- Set a Reasonable Salary: Use industry surveys, your duties, prior earnings, or even IRS guidance (Publication 15-A) to set a defensible wage.
- Distribute Remainder: Pay out business profit after salary and expenses as a shareholder distribution, recording them in your bookkeeping.
- Document Everything: Save pay stubs, annual payroll tax filings, and board resolutions if applicable.
Example scenario: Jane, a marketing consultant, nets $100,000. Pays herself $55,000 (salary), takes $45,000 (distribution). Tax bill drops by $6,885 versus sole prop—year after year.
What If I Choose Too Low a Salary in My S Corp Salary Split?
Going too low gets the IRS’s attention.
They want to see a wage similar to what you’d pay someone else for the same job, not a symbolic $12,000 salary with $88,000 distributions. Pick a number you can justify.
What Most Owners Get Wrong: Red Flags & Audit Traps
Here’s the myth: “Set your salary as low as you want—nobody checks.” In reality, IRS computers catch abnormally low salaries every tax season. In 2024, S Corp audit rates tripled for owners with near-zero W-2 wages attached to 6-figure S Corp earnings.
If you fail the ‘reasonable salary’ test, you could owe all missed payroll taxes plus a 100% penalty, interest, and possibly a “failure to file” fine—and these cases are up in 2025 (IRS S Corp rules).
- ✅ Don’t use $0 salary—instant target.
- ✅ Avoid ‘max distribution, min salary’ approaches that lack rationale.
- ✅ Document with industry data or job posting comparables.
💡 Pro Tip: Use an online payroll service to calculate and document your wages—for most S Corp owners, the cost runs $50–$100/month and saves hours. It also creates a trail proving compliance.
What Salaries Get Flagged?
Salaries under $40K for full-time; less if part-time or seasonal. IRS spot-checks are algorithmic—so, if in doubt, round up but don’t overpay either.
What Happens to Retirement and Health Deductions?
S Corp salary split means only your “salary” counts for things like 401(k) contributions or SEP IRAs. Distributions do not. Don’t underpay yourself so much that you miss out on retirement savings or Social Security credits.
Example: Joe takes a $60K salary, $40K distribution. Can max out employee 401(k) based on salary, but not the $40K extra.
Health insurance: S Corp can deduct premiums for you, but must be run through payroll and reported on your W-2 (Box 1, not subject to Social Security/Medicare taxes).
How to Prove Your S Corp Salary Split Is ‘Reasonable’
The IRS looks at job duties, local wage surveys, and compensation for similar roles. Document com parables now—don’t wait for a notice.
Why Smart Owners Pair S Corp Strategy with Accountable Plans
An overlooked save: Pairing the S Corp split with an accountable reimbursement plan.
This lets you reimburse yourself (tax-free) for business expenses like home office, mileage, or supplies, off your W-2, lowering your effective salary without triggering audit suspicion. Set a written plan, pay documented expenses, and keep receipts.
Example: Amy, S Corp owner, reimburses $7,200/year for legitimate expenses, lowering taxable wage without IRS red flags.
But What If I’m a One-Person Business?
Solo S Corps are eligible. You create the plan, document the expenses, and keep excellent records. IRS scrutinizes documentation, not headcount.
Red Flag Alert: Common Mistakes That Trigger Payroll Penalties
The biggest mistake: Good intentions, bad records. Owners who get hit with back taxes often skipped payroll filings, misclassified bonuses, or pocketed all profits as untaxed distributions.
The IRS can audit 3+ years back and assess the full missed payroll tax, plus a 100% penalty. In 2025, these cases are rising as the IRS automates S Corp compliance sweeps.
- ❌ Forgetting to file quarterly payroll returns (Form 941)
- ❌ Misreporting wages on W-2 vs. K-1
- ❌ Missing required state payroll compliance, not just federal
Simple fix? Use a payroll service and make monthly/quarterly filings a recurring calendar event.
FAQ: Navigate S Corp Salary Splitting in 2025
What If My Business Profit Fluctuates Year to Year?
Adjust your salary annually. IRS wants “reasonable” based on what you actually make, versus a fixed percentage. In slow years, pay less; in big years, adjust upwards.
Do I Need to File a Separate Tax Return for My S Corp?
Yes—IRS Form 1120-S for the S Corp, plus a K-1 for each shareholder. This is in addition to your personal 1040. Most bookkeepers or tax pros handle this, but don’t forget to file—penalties are steep and automatic after the March 15 deadline.
What Happens If I Get Audited?
If you’ve documented your process, matched industry norms for salary, and can show the work you do, you’re fine. Worst case? IRS reclassifies some distributions as wages—you’ll owe payroll taxes plus interest, but no crime or fraud if it was a good-faith mistake.
Can I Deduct My Home Office Through My S Corp—or Personally?
Yes, if properly documented. You must set up a formal reimbursement (accountable) plan through the S Corp, not just claim on your personal return. Pay yourself from the S Corp and track the square footage and business use.
How Soon Can I Start Saving If I File an S-Corp Election Today?
If filed by March 15, the S Corp can be effective for the current year. File late? The election becomes valid starting next tax year.
What Documentation Does the IRS Want to See in an Audit?
Payroll records, timesheets, W-2s, board notes on salary decisions, and invoices for reimbursed expenses.
Can I Go Back and ‘Fix’ Last Year’s Salary if I Made a Mistake?
Yes, with a “reasonable cause” explanation and paying missed payroll taxes. Avoid willful disregard—the IRS penalizes intent, not honest oversights.
Pro Tip Shortcut Block
Payroll setup lets you route health insurance and retirement contributions through your salary—don’t self-sabotage by underreporting wages to chase a bigger distribution.
Bottom Line: How to Book a Real Strategy Session
Most small business owners are throwing away $10,000–$20,000 a year on extra self-employment taxes by staying LLC-only. S Corp salary splits and accountable plans protect savings—but only if set up and documented correctly.
Don’t leave your next $12,000 on the table because you fear the IRS. You’ve earned it, and the IRS allows it for those who play by documented rules.
Ready to shatter your self-employment tax bill?
