The California S Corp Salary Trap: How Much Is “Reasonable” in 2025?
what is reasonable salary for s corp California is the question that sends a chill through many S Corp owners, especially in tech and consulting-heavy California. Still, each year thousands try to “game” their salary—or worse, delegate the decision to their payroll provider. In 2025, the IRS and FTB are actively targeting S Corps for underpayment, and misunderstanding this rule can turn a modest tax win into a five-figure audit disaster.
Quick Answer: What Does the IRS/FTB Want for S Corp Salary?
For the 2025 tax year, both the IRS and California Franchise Tax Board require S Corp owners to pay themselves a “reasonable” salary that matches what they’d pay an employee to do the same work. This is not a flat percentage or a pick-your-rate exercise. The salary must reflect job duties, market value, and actual hours worked. Failure to comply risks steep penalties, back-payroll taxes, and possible entity suspension.
Decoding “Reasonable” Salary: Rules, Benchmarks, and Examples
The crux: the IRS (per IRS S Corporation Guidance) and FTB will judge your S Corp payroll by what you’d pay a non-owner for the same work. They examine market salary databases (think Glassdoor, BLS), duties performed, location, company profits, and hours. If you’re a software consultant generating $220K in net S Corp profit but pay yourself only $30K, you are painting a bullseye on your back.
- Persona Scenario #1: Rachel is an S Corp owner in San Jose building web apps. She takes $40,000 salary and $120,000 in distributions. Local salary data shows developers earn $130,000+. If audited, Rachel could face $90K in back taxes and penalties for “unreasonably” low pay.
- Persona Scenario #2: Mike operates a marketing S Corp out of Sacramento. He pays himself $65,000, but labor-market analysis shows marketing directors not performing sales make $80,000. The IRS can force Mike to adjust upward and collect unpaid payroll taxes plus penalties.
💡Pro Tip: Never assume you can “fly under the radar” in high-audit areas like California. Use real salary data from sources like BLS or Glassdoor for backup documentation.
How to Document Your Salary and Defend Your S Corp Split
If the IRS or FTB comes calling, you need more than a generic pay stub. Detailed records supporting your rationale are your audit shield. Here’s what that should include:
- Job description outlining your exact duties
- Time tracking (even weeks of hours worked per quarter)
- Salary Research printouts for your role/region
- Profit/loss statements validating business income
- Board meeting notes or resolutions (for midyear salary changes)
Persona Scenario: Lin runs an S Corp real estate brokerage in LA. She logs her hours, keeps records from Payscale and BLS, and, after discussing with her advisor, sets her salary at $110,000. In an FTB payroll audit, Lin’s documentation closes the file—no adjustment needed, while her office neighbor faced $28,000 in penalties for “guess-timated” salaries.
Audit Red Flags: What Gets S Corps Into Trouble in California
🔴Red Flag Alert: California S Corp owners are 2x more likely to face payroll audits than those in other states (FTB statistics, 2024). Key triggers include:
- Setting salary below 35% of total S Corp profit (for high-margin service firms, this is scrutinized aggressively)
- No documentation of job duties, role, or comparable salaries
- Sudden, drastic drops in salary year-over-year
- Salary inconsistent with W-2 employees doing comparable work
💡Pro Tip: If your business has seasonal income or you wear multiple hats, adjust salary mid-year—just document the reason and approval process.
Will Setting a Lower Salary Actually Save on Taxes?
Many S Corp owners think minimal salary means minimal tax—but the compliance risk far outweighs savings beyond the “reasonable” threshold. Example: If your net S Corp profit is $180,000 and you pay yourself $50,000, the IRS can re-characterize $80,000 of distribution as salary and assess payroll tax plus 25–50% in penalties. Instead, a more compliant setup—say, $90,000 salary and $90,000 distributions—saves self-employment tax but passes IRS scrutiny. That’s $11,000 in social security/Medicare savings (vs LLC), but only if justified by the numbers.
Bottom line: For 2025, expect increased scrutiny on S Corp owners in California due to higher audit risk and cross-checking with FTB data. Don’t play chicken with “lowball” payroll numbers, especially not in tech, consulting, or law.
How to Get This Right: A Step-by-Step Payroll Setup for 2025
- Define your main role and time allocation in the S Corp.
- Research salary data for your title and region (see BLS).
- Set salary above the local median for your specialization if you want an audit buffer.
- Document everything—time logs, salary survey screenshots, and rationale.
- Process payroll through a legitimate provider (no “memo to self” checks).
- File payroll tax forms quarterly and annually (IRS Form 941, CA DE9, etc.).
- Review salary annually to adjust for inflation or changing business mix.
- Have your tax advisor review the salary split for 2025 and beyond.
Scenario: Carlos, an S Corp owner in San Diego, increased his salary from $70,000 to $95,000 after his advisor showed that new FTB enforcement teams were flagging anything under $80,000 for his consulting sector. Result? Zero audit issues and a clean tax return.
FAQ: What California S Corp Owners Ask Most
Can I pay myself a salary at year-end only?
No. IRS requires wages to be “paid and received” during the year. Salary must be regular and consistent to count.
What if my business loses money?
If there’s no profit, you may not need a wage, but the moment the business is profitable, pay a salary that matches your market value for time worked.
Is there a safe percentage to use?
There’s no IRS or FTB safe harbor, but many advisors use 40–60% of total S Corp profits as a general reference point, cross-checking industry pay rates for accuracy.
Why Most S Corp Owners Get This Wrong
The biggest trap is “set it and forget it” payroll. S Corp owners either go too low to save tax (risking audits) or too high, eliminating the entity’s unique tax advantage. The key is to match your reasonable salary to your true role, hours, and market benchmarks—adjusting for business performance year over year and documenting everything. This isn’t just paperwork; it’s the core of S Corp compliance and the only way to withstand IRS and FTB challenge in California for 2025.
Book Your Reasonable Salary Tax Review
If you’re unsure whether your S Corp salary is setting you up for a five-figure audit, book a strategy session with our team. We’ll benchmark your wages, show you real-world audit cases, and design a tax-saving split that defends your wallet—from IRS and FTB, with confidence. Click here to secure your Reasonable Salary Review now.
Mic-Drop Line:
The IRS isn’t hiding the rule—they’re just waiting for you to get it wrong.
Top 3 Social Media/Email Takeaways:
- Most CA S Corp owners underpay themselves and risk five-figure tax bills. Get your market salary right for 2025, or the FTB might decide for you.
- A “reasonable salary” isn’t a guess—it’s evidence-based. Document your rate with BLS or Glassdoor data for a real audit defense.
- Your S Corp tax advantage hinges on this split. Ignore at your bank account’s peril—schedule your Reasonable Salary Review.
This information is current as of 7/3/2025. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.
