Electing S-Corp status can save a small business owner real money on self-employment tax. The savings come with one rule that trips up many owners: you have to pay yourself a reasonable salary through payroll before you take distributions.
The end of the year is when that rule matters most, because payroll you skip in 2026 can't be fixed in 2027.
What "reasonable" means
The IRS expects an S-Corp owner who works in the business to earn roughly what they'd pay someone else to do the same job. There's no single formula. Things that matter include:
- The work you actually do (owner, estimator, technician, bookkeeper, salesperson)
- Hours worked and your experience
- What similar businesses in our area pay for that role
- How profitable the business is and how much you take out in distributions
A salary of $0 while taking $80,000 in distributions is a red flag. So is paying yourself $12,000 when you work full time running a crew.
Your year-end checklist
- Add up your 2026 salary so far. Is it on track with what you and your tax preparer agreed on?
- Compare salary to distributions. If distributions are far larger, talk with your tax preparer now.
- Run any catch-up payroll in December. A final paycheck before December 31 can bring your salary where it needs to be. Withholding and payroll taxes get reported on your W-2 and year-end payroll filings.
- Record your health insurance correctly. For owners with more than 2% of the company, S-Corp-paid health insurance generally belongs on the W-2. Ask your preparer how to handle it.
- Keep distributions clean. Record them as distributions, not wages or expenses, and don't let them outpace your basis.
Why your bookkeeping matters
Your tax preparer builds your S-Corp return and your personal return from your books. If owner pay, distributions and personal expenses are all mixed together, you'll pay for cleanup, or worse, for mistakes.
This post is general information, not tax advice. Your tax professional can help you set a reasonable salary for your situation.
Lines & Ledger handles S-Corp bookkeeping, owner payroll and distribution tracking for small businesses in Bowling Green and across Kentucky. Let's talk before year-end.
