His salary was set when the company did $900,000 a year. It does $4 million now (example numbers).
That was seven years ago, and the number made sense back then. He ran one crew, did his own estimates and pulled his own permits. Since then he added three crews, a shop and a second office. He stopped swinging a hammer and started running a company.
The salary never moved. The distributions grew every single year. Nobody revisited it, because nothing ever broke.
That is how most S corp salary problems start. Not with a bad decision, but with a good decision that was never checked again. A number that was right for a smaller company quietly stopped being right for this one.
This post is for owners who already made the S corp election. If you are still deciding whether to elect, start with S corp vs LLC for contractors. If you are already in, the question is simpler and more important: is your salary still the right number?
Your Salary Has One Job
In an S corp, the money you take out comes in two forms. Salary runs through payroll and carries Social Security and Medicare tax, like any paycheck. Distributions of the remaining profit do not carry those taxes. That difference is the entire reason the election saves money.
It is also why the IRS cares how you split the two. An S corp has to pay a shareholder who works in the business reasonable compensation for those services before it makes non-wage distributions to that shareholder.
So your salary has one job: match what the role is worth. Too low invites questions. Too high pays payroll tax a distribution would not. Neither one is a strategy. Accurate is.
Too Low: The Zero-Salary S Corp
Zero salary and $180,000 in distributions (example numbers). On paper it looks like the smartest S corp in town.
It is also the shape the IRS looks for. When an owner who runs crews, prices jobs and handles the biggest customers takes little or no wage, distributions can end up treated as wages, with back employment taxes, penalties and interest attached.
There is no formula in the tax code for “reasonable.” Courts decide it case by case, and the IRS lists the factors they weigh:
- Training and experience
- Duties and responsibilities
- Time and effort devoted to the business
- Dividend history
- Payments to non-shareholder employees
- Timing and manner of paying bonuses to key people
- What comparable businesses pay for similar services
- Compensation agreements
- The use of a formula to determine compensation
For a contractor, most of that list comes down to one practical question: what would you have to pay someone else to do your job?
Too High: The Cost Nobody Talks About
Most of the talk about owner pay is about salaries set too low. A salary set well above what the role is worth costs you too, just quietly.
Say a defensible salary for your role is $140,000, but you pay yourself $200,000 because it felt safer (example numbers). For 2026, Social Security tax applies to wages up to $184,500, and Medicare applies to all of them. That extra $60,000 of wages carries roughly $7,250 a year in combined employer and employee payroll tax that a distribution would not, before the small offset from deducting the employer’s share.
Spread over 26 paychecks, that is about $280 each. Nobody notices. Over five years, it is more than $36,000.
Higher wages are not always a pure loss. Salary can affect how much you can put into some retirement plans, and it interacts with the qualified business income deduction. That is exactly why the right salary is a modeled number, not a gut number. The goal is not low or high. It is accurate.
When the Company Outgrows the Salary
Back to the $4 million company. At $900,000, the owner’s role was a working foreman who also sold the jobs. A low salary made sense for that role.
At $4 million, the role is different. He is the general manager, the senior estimator and the person who closes the biggest contracts. That is a bigger job with a bigger market wage, and the salary set seven years ago does not describe it.
The reverse happens too. An owner who has hired a general manager and stepped back to sales and strategy may be doing a smaller job than when the salary was set.
A practical way to test the number is what the IRS’s own valuation staff call the “many hats” approach, built for small companies where one owner does several jobs:
- Write down every role you actually fill: field supervision, estimating, sales, project management, general management, bookkeeping.
- Estimate the hours per week you spend in each.
- Price each role at what it pays in your market. Bureau of Labor Statistics wage data and local job postings are good starting points.
- Add it up. The result is a range, not a single figure, and your salary should sit inside it.
Then write down how you got there. A one-page memo with your roles, hours and market rates is what turns a guess into a position you can defend.
What Your Salary Does to Your Profit, and to a Buyer
Ask a room of contracting owners what they pay themselves and half of them laugh. Then they say forty grand, or nothing, and they take draws when the account allows it.
The books then show a big profit, and the owner feels like it is fake. It is not fake. It is just missing a line. Somebody runs that company sixty hours a week, and that job has a market wage.
A buyer will find that line for you. Picture an HVAC company doing $5.8 million where the owner pays himself $70,000 while running sales, pricing every large install and handling the biggest accounts (example numbers). A buyer does not see a $70,000 role. He sees a job that would cost $180,000 to fill, and he subtracts the difference from the profit he is willing to pay a multiple on. If a sale is anywhere on your horizon, owner pay is part of what your contracting business is worth.
Owner pay sits where your tax return and your valuation meet. It deserves to be set on purpose for both.
Set It on Purpose Before December 31
Salary changes run through payroll, so this year’s number has to be fixed before the year closes. If your salary is too low for the role you now fill, a catch-up through payroll before December 31 can bring 2026 in line. If it is too high, the time to change it is the start of next year’s payroll, not after the fact.
A short checklist:
- Re-run the “many hats” exercise for the role you fill today, not the one you filled when you elected.
- Compare the result to what you actually paid yourself this year.
- Decide the 2026 adjustment, if any, while there are still payroll runs left.
- Fold the salary decision into your year-end tax plan alongside estimates and equipment, because they all draw on the same profit.
- Put a date on next year’s calendar to check it again.
Salary is one of the few levers that is fully in your hands every year, which is why it belongs in tax planning, not just tax filing.
Where to Start
About ten weeks are left in the year, and your own paycheck is still an open decision. Owner pay is part of Level 2, Tax Strategy and Wealth, in the free 5-minute Contractor Growth Assessment, which scores your business on six areas and shows which one is holding the others back.
Take the free Contractor Growth Assessment →
This article is general information, not tax advice for your specific situation. Reasonable compensation depends on your role, your market and your numbers.
