Since the legal avoidance of payroll taxes is a prime motivator for organizing an S-Corporation, many myths have formed over the years to enhance the avoidance of these payroll taxes. They are myths because they will noit pass IRS scrutiny.
Years ago, the S-corp tax form (1120-S) did not break out shareholder and non-shareholder wages. That has changed. Wages/salary are broken down between shareholders and non-shareholders. The IRS now has it easy in identifying reasonable compensation to owners, or non-reasonable compensation.
This was never a guideline or rule issued by the IRS, the Tax Court, or in regulations. Many myths have developed over the years regarding Reasonable Compensation. In fact, a $10,000 salary has nothing whatsoever to do with reasonable compensation to shareholders.
Since the legal avoidance of payroll taxes is a prime motivator for organizing an S-Corporation, many myths have formed over the years to enhance the avoidance of these payroll taxes. They are myths because they will not pass IRS scrutiny.
Not true! While the SS wage base ($176,100 in 2025) is much higher than the $10,000 myth, it is still not a rule or guideline. Social security wage base is not reasnable compensation because it might encourage the business over to over-compensate her wage/salary over fear of IRS scrutiny.
Excess compensation to the shareholder employee can cause a lost deduction on the excess salary.
The 60/40 and 50/50 rule is based off a percentage of profits. With this rule, the owner takes either 50% or 60% of profits as a salary, depending on the rule in question.
Inside the tax profession, many professionals use one of these rules or something similar. It's important to note that it's not officially approved by the IRS.
Tuesday Accounting only uses the three IRS approved methodologies.
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