Pay Yourself Properly as a Small Business Owner

Running a small business means juggling passion, profitability, and a never‑ending stream of paperwork. Somewhere in the middle of that whirlwind sits a question many owners struggle with: How much should I pay myself? It’s a decision that can feel fuzzy, but guessing your way through it can create serious problems—both for your taxes and for the long‑term health of your business.

Why Your Salary Matters More Than You Think

The way you compensate yourself affects compliance, cash flow, and your company’s stability. Too many owners set their salary based on convenience rather than strategy, which can put them at odds with IRS expectations. A thoughtful approach ensures you’re both compliant and fairly paid for the work you put in every day.

What “Reasonable Compensation” Really Means

A reasonable compensation analysis is the framework the IRS uses to assess whether an owner’s salary makes sense. Instead of pulling numbers from thin air, this structured process looks at your responsibilities, the time you spend in the business, salary benchmarks in your industry, and even regional wage data. It’s designed to answer one essential question: What would you have to pay someone else to do your job?

What the IRS Actually Looks At

There’s no single formula—and definitely no shortcuts. The IRS evaluates several factors when determining whether an owner’s pay is appropriate, including:

  • Your training, background, and experience
  • The range of duties you perform
  • How profitable your business is
  • Compensation paid to comparable employees
  • Your company’s historical pay practices

All of these pieces help paint a full picture of what “reasonable” should look like.

Why Paying Yourself Too Little Can Backfire

Many owners try to keep taxes low by taking minimal salaries and relying heavily on distributions. But underpaying yourself can trigger serious consequences. The IRS may reclassify distributions as wages, resulting in back taxes, penalties for employment tax errors, and—if things get messy enough—even threats to your S corporation status. A short‑term savings strategy can quickly turn into a long‑term headache.

The Myth of the 60/40 Rule

You may have heard rules of thumb like “take 60% salary and 40% distributions,” but the IRS doesn’t accept formulas that generalize across businesses. Every company and every owner is different. The only truly defensible approach is one that reflects your unique duties, market data, and business performance.

The Power of a Structured Approach

Using a strategic compensation analysis does more than keep you compliant. It helps reduce audit risk, supports better financial planning, and ensures that you—the person driving the business forward—are paid fairly for your work. It’s a small step that carries a lot of protective power.

Make Compensation Part of Your Business Strategy

Paying yourself isn’t just about cutting a paycheck. It’s about building a strong, audit‑proof foundation for your business. As you grow, revisit your compensation strategy regularly and make sure it still aligns with IRS standards and your company’s financial reality.

If you’re unsure whether your current salary is reasonable or defensible, now is the time to take a closer look. Schedule a Consultation with us to help you evaluate your structure and ensure you’re making smart, compliant decisions for the future.