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Salary pays FICA. Distributions lose QBI. The right number is in the middle — and defensible.
The S-corp election exists for one reason: profit taken as distributions skips the 15.3% payroll tax that salary pays. On $200,000 of profit, paying yourself $80,000 of salary saves about $15,994 versus sole-prop self-employment tax. But two forces push back: salary reduces your QBI (the 20% pass-through deduction applies only to profit AFTER wages), and the IRS requires "reasonable compensation" — set salary too low and they reclassify distributions as wages with back taxes and penalties. There's no bright-line formula; courts ask what you'd pay a stranger to do your job. This calculator prices both sides — payroll saved, QBI lost, net advantage — and flags the reclassification risk zone.
S-corp owners use it at salary-setting time: payroll tax saved (15.3% on distributions) minus QBI lost (6.4¢ per salary dollar at the 32% bracket) is the real net — and the <40%-of-profit flag marks where reclassification risk starts.
No statute defines it — courts use the market test: what would you pay an unrelated person to do the same work (Rev. Rul. 59-221 and decades of Tax Court cases). Factors: your duties, hours, experience, what comparable employees earn, and how much profit comes from your labor versus capital. Practitioner heuristics run 40–60% of profit or market wage, whichever you can document. A $30,000 salary on $300,000 of professional-service profit is the fact pattern that loses in court.
Two reasons. First, audit: reclassification converts distributions to wages retroactively — back FICA, penalties up to 100% of the tax, and interest. Second, QBI: wages aren't qualified business income, so each salary dollar forfeits 20% × your bracket of deduction value. At the 32% bracket that's 6.4¢ per salary dollar — the savings from dropping salary further is only ~8.9¢ on the margin, not the headline 15.3%. And above the $184,500 Social Security base, the spread shrinks to Medicare's 2.9%.
On profit above a reasonable salary. The sole prop pays 15.3% (on 92.35% of profit) on everything; the S-corp pays FICA only on salary. On $200,000 of profit with an $80,000 salary, that's roughly $16,000 of payroll tax saved, minus about $5,000 of QBI deduction lost at the 32% bracket — net ~$10,900 a year, before the extra costs: payroll service, a second tax return (1120-S), and state franchise taxes in places like California. Below roughly $50,000–$80,000 of profit, those fixed costs usually eat the savings.