By: Isla Carmichael

Why Payroll Optimization Matters for S Corporation Owners

Payroll is one of the most important tax planning tools available to S corporation owners. Choosing the right payroll amount directly impacts self-employment taxes, income taxes, the Qualified Business Income deduction, and IRS compliance. Optimizing your payroll helps you reduce taxes while maintaining a structure that the IRS recognizes as legitimate.

Understanding how payroll works in an S corporation is essential for maximizing tax efficiency in 2025.

Understanding Reasonable Compensation

The IRS requires S corporation owners who provide services to the business to pay themselves a reasonable salary. Reasonable compensation is based on:

• Industry standards
• Your role in the business
• Hours worked
• Experience and qualifications
• Profit level
• Comparable pay for similar roles

Setting wages too low can trigger IRS scrutiny. Setting them too high increases payroll taxes unnecessarily.

How Payroll Impacts Tax Savings

Payroll affects three major tax areas:

• Self-employment tax
• Income tax
• Qualified Business Income deduction

The goal is to set payroll at a level that minimizes tax burden without violating reasonable compensation rules.

Balancing Salary and Distributions

S corporation owners can take income in two ways:

• W2 salary
• Shareholder distributions

Salary is subject to payroll taxes, while distributions are not. The key is striking a balance that satisfies IRS requirements and maximizes savings.

Common Payroll Ranges Based on Profit

While every business is unique, profit levels often guide payroll strategy:

• Below 80k profit: moderate salary
• 80k to 250k profit: salary that reflects core workload
• 250k to 600k profit: optimized salary with structured distributions
• 600k plus profit: advanced planning may involve multi-entity strategies

Your advisor evaluates your specific situation to determine the ideal payroll.

How Payroll Affects QBI

The QBI deduction allows eligible taxpayers to deduct up to 20 percent of qualified business income. Payroll impacts QBI in two ways:

• Lower salary increases business profit, increasing QBI
• However, high-income taxpayers need enough wages to satisfy the wage-based QBI tests

For higher earners, payroll must be optimized with QBI calculations in mind.

Using Accountable Plans to Reduce Taxable Payroll

S corporations can reimburse owners for business expenses through an accountable plan, which:

• Reduces taxable income
• Lowers payroll taxes
• Increases deductions
• Improves documentation

Examples of reimbursable expenses include:

• Home office costs
• Mileage
• Cell phone use
• Supplies
• Travel for business

These reimbursements are not considered wages.

Avoiding Common Payroll Mistakes

S corporation owners frequently make errors that increase taxes or risk audits. Common mistakes include:

• Paying no salary
• Paying too little
• Paying too much
• Failing to run payroll consistently
• Not issuing W2s
• Ignoring payroll tax filings
• Not using an accountable plan
• Commingling business and personal expenses

Correcting these mistakes improves tax outcomes immediately.

Why You Cannot Skip Payroll

Some owners mistakenly believe they can take distributions without payroll. This violates IRS rules because:

• Owners must be paid for work performed
• The IRS classifies unreasonably low wages as tax avoidance
• Back taxes and penalties may be assessed

Running legitimate payroll is non-negotiable.

Timing Payroll Strategically

Payroll can be timed strategically during the year to:

• Manage cash flow
• Increase or decrease QBI
• Adjust for profit changes
• Support estimated tax planning

Year-end adjustments may help align payroll with updated financial results.

Incorporating Retirement Contributions

Payroll decisions affect retirement planning. Higher wages may allow larger contributions to:

• Solo 401(k)s
• SEP IRAs
• Traditional 401(k)s

Your advisor balances payroll strategy with retirement goals.

Considering Payroll for Multi-State Operations

If your business has employees or operations in multiple states, payroll must align with:

• State income tax rules
• State unemployment insurance
• Local payroll tax requirements

Proper planning prevents errors and penalties.

Using Payroll Software to Maintain Compliance

Payroll must be accurate and timely. Software helps automate:

• Withholding
• Tax deposits
• Quarterly filings
• W2 issuance
• Record keeping

Your advisor ensures the system works correctly for your business.

How AE Tax Advisors Optimizes Payroll

AE Tax Advisors evaluates every aspect of your financial picture to determine the ideal payroll. Services include:

• Reasonable compensation analysis
• QBI calculation
• Annual payroll strategy
• Accountable plan setup
• Distribution planning
• Multi-state payroll compliance
• Entity review
• Documentation support

This ensures your payroll aligns with IRS rules and tax-saving goals.

Final Thoughts

Payroll is one of the most powerful tax planning levers available to S corporation owners. When optimized correctly, it reduces tax burden, increases QBI deductions, and keeps you fully compliant. By combining proper payroll structure with strategic planning, you can significantly lower your tax bill in 2025 and build a more efficient business.

For high-income individuals who want a strategic partner steering their tax planning, more information is available at AETaxAdvisors.com.

Disclaimer: The information provided in this article is for general informational purposes only and should not be construed as financial, tax, or legal advice. While the article aims to highlight common strategies and trends, it does not consider individual circumstances. Readers are encouraged to consult with a qualified professional for advice tailored to their specific situation.