Salary vs. Distributions for Business Owner Compensation

The good news? With the right strategy and guidance, you can reduce audit risk, optimize your income, and retain more of the wealth you’ve worked so hard to build.

Understanding Salary and Distributions

Let’s start with the basics. Business owners typically pay themselves in one of two ways:

A salary, taxed through payroll like any employee
Distributions, also called owner’s draws or shareholder distributions, which bypass payroll taxes but are still taxable in other ways

How you combine or choose between the two depends heavily on your entity type, and that’s where strategic tax planning makes all the difference.

If You’re a Sole Proprietor or Partnership: Salary Isn’t an Option

Under sole proprietorships or general partnerships, owners cannot legally pay themselves a salary. Instead, you take an owner’s draw from the business’s net profits.

This method feels simple, but it’s far from tax-efficient at scale. Your draw isn’t subject to payroll withholding, but all net profits pass through to your individual tax return and are subject to self-employment taxes, currently 15.3%. You’ll also miss the business owner tax deductions tied to formal payroll structures.

As your business grows, this structure may hinder you, especially once you’re netting six or seven figures.

Explore Allmon DiBernardo & Associates’ tax planning services to learn more about our bespoke strategies for minimizing tax burdens and guiding you toward long-term financial success.

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S-Corps and C-Corps: Balancing Salary and Distributions

Owners of S-Corporations and C-Corporations can (and must) treat themselves differently. These structures open the door to mixing reasonable salary with distributions, and that’s where things get strategic.

In an S-Corp, for example, the IRS requires owner-employees to pay themselves a reasonable salary for their work. That salary is subject to payroll taxes. But any remaining profits can be distributed without triggering additional self-employment tax, saving you thousands each year.

For C-Corps, the rules are different. The company pays corporate tax on profits, and you pay individual tax on your salary and dividends. Without careful business planning, this can result in double taxation. But with the right mix of salary and fringe benefits, plus strategic timing of distributions, you can reduce the overall liability.

The key is finding the balance that meets IRS requirements and protects your income from unnecessary taxation.

Explore strategies for structuring your business in a growth-forward and tax-efficient way in this insightful guide.

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The IRS doesn’t publish a specific formula for reasonable compensation, but they take it seriously. If you’re paying yourself too little in salary to avoid payroll taxes, they’ll see that as a red flag.

Reasonable compensation is based on what someone else would be paid for a similar role, considering factors like:

Industry standards
Your level of involvement
Duties and hours worked
Company size and revenue

For example, if your S-Corp nets $500,000 and you only pay yourself a $30,000 salary, that could be an issue. But if you’re involved in daily operations and your role matches a typical $120,000 position in your industry, that’s your benchmark.

A strategic CPA can help document your reasoning, avoid costly IRS scrutiny, and minimize your tax burden to set you up for scalable growth.

Explore Allmon DiBernardo & Associates’ accounting services to learn how we help small business owners strategically build wealth, limit tax exposure, and scale.

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Business Owner Tax Deduction Strategies Depend on Pay Structure

How you pay yourself also affects which business owner tax deductions you can take.

Paying a formal salary allows your company to deduct wages and employer payroll taxes, reducing business income. You can also access retirement contributions, health benefits, and other fringe benefits that are deductible to the business and (sometimes) tax-free to you.

Distributions, on the other hand, don’t offer these business-level deductions, but they avoid payroll taxes, which can be substantial as income rises.

With thoughtful income tax planning for business owners, you can structure compensation to balance short-term tax savings with long-term wealth accumulation.

Tax Planning for Business Owners: When Salary Becomes Too Costly

The higher your salary, the more you pay in:

Payroll taxes (Social Security and Medicare)
State and federal income taxes
FUTA and SUTA (unemployment taxes)

Once your compensation passes certain thresholds, payroll tax efficiency starts to drop. That’s when increasing your use of distributions may make sense.

But there’s a catch: relying too heavily on distributions without adequate salary exposes you to audit risk. The IRS watches for this in high-income S-Corp owners. It’s why real-time business planning, not end-of-year scrambling, makes all the difference.

Adjusting Compensation as You Grow

As revenue increases, so should your compensation strategy. What worked when you earned $150K may be working against you at $750K.

Key triggers for reviewing your pay structure include:

Crossing into a new tax bracket
Adding employees and expanding operations
Taking on investors or preparing for a future business exit
Accumulating retained earnings beyond operational needs

Strategic business owner tax deduction planning requires periodic adjustments to compensation. A CPA who understands your complete financial picture, not just your tax forms, can help you optimize every dollar.

Advisory CPA Services Help You Plan, Not Just File

Most business owners never revisit how they pay themselves. Their tax preparer files what’s handed over and maybe suggests a tweak here and there.

But that’s not a strategy. That’s compliance.

Advisory CPA services go beyond filing to build a customized plan for your goals. They help you:

Forecast income and plan quarterly estimates
Adjust compensation to meet cash flow needs and tax efficiency
Maximize deductions through salary and benefit planning
Minimize audit risk through proper documentation
Coordinate your personal and business financial goals

If your accountant isn’t doing this, it’s time to upgrade.

Is your accountant helping you build wealth or just filing returns? Find out how to evaluate your CPA’s services in this helpful guide.

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Business Planning With a Strategic CPA

Working with a strategic CPA is about making sure your business is structured to work for you.

Here’s how a strategic CPA brings value:

Entity guidance: Choosing (or switching to) the proper structure to allow for optimal salary/distribution mix
Compensation modeling: Running the numbers on different pay scenarios to maximize take-home income
Audit-proof planning: Aligning salary decisions with IRS expectations and industry norms
Cash flow insights: Matching pay schedules with business seasonality to avoid cash crunches
Integrated wealth strategy: Coordinating business compensation with retirement, investments, and tax deferral tools

This is tax planning for business owners done right, and it can be the difference between surviving tax season and thriving year-round.

Work With Experts at Allmon DiBernardo Who Know How to Maximize Your Compensation

At Allmon DiBernardo, we don’t just help business owners pay themselves; we help them pay themselves smarter. Through proactive planning, entity optimization, and ongoing strategy, we ensure your compensation plan supports your lifestyle and long-term goals.

Let’s take the guesswork and the overpayments out of your salary vs. distributions decision..

Contact us today to schedule a compensation strategy review and discover how our tailored guidance can reduce your tax exposure and increase your take-home income.