S corporation taxes: salary, distributions and the basics owners should understand

Owners often hear that an S corporation "saves taxes." Sometimes the numbers work; sometimes the added cost and complexity outweigh the benefit. Understanding the mechanics first makes the decision much easier.

What the election does An S corporation election changes how the business is taxed, not what it legally is. An LLC or a corporation may be eligible to elect it if the requirements are met, including limits on who may own shares. Profit generally flows through to the owners' personal returns rather than being taxed at the corporate level.

The salary and distribution structure An owner who works in the business is an employee of it. That means: - Reasonable compensation. The owner must be paid a reasonable wage for the work performed, through payroll, with the associated withholding and employment taxes. - Distributions. Remaining profit may be distributed to owners without being wages. - The reason it can help is that distributions are not subject to employment taxes the way wages are. The reason it must be handled carefully is that "reasonable" is a facts-based standard, and paying an artificially low salary is a well-known audit issue.

There is no universal percentage or formula. Reasonableness depends on the role, hours, experience, industry, what comparable work pays and what the business earns.

The costs that come with the election - Running real payroll, with deposits and quarterly and annual filings. - A separate business return for the entity, plus owner reporting. - More bookkeeping precision, since owner compensation, distributions and basis need to be tracked. - State treatment that varies — some states impose their own taxes or fees regardless of the federal election.

When owners typically model it When profit is consistently well above what the owner would pay themselves as a wage, the business is stable, and the added administrative cost is small relative to the potential benefit. When profit is modest or volatile, the election often costs more than it returns.

Mistakes we see - Making the election and never running payroll. - Taking distributions all year with no wage, then trying to fix it in December. - Ignoring state-level rules and filings. - Paying personal expenses from the business account, which complicates both the accounting and the defense of the structure.

This is general educational information about how the rules work, not advice for your business — the analysis depends on your numbers, your role and your state, and it should be modeled before the election, not after. We run that analysis with clients and handle the payroll and filings that follow. Contact us to look at your numbers.