S-Corp paying myself $40k salary but taking $150k in distributions - audit risk?

I run an IT consulting business as an S-corp. My accountant set me up with a $40k salary and I'm taking about $150k in distributions this year. Total revenue is around $190k.

I just read an article about the IRS cracking down on S-corps with low reasonable compensation. Am I setting myself up for an audit? My accountant says it's fine but now I'm worried.

For context: I'm the only employee, I do all the work, and I live in Texas. What's actually considered "reasonable" here?

Yeah, that ratio seems really aggressive. The whole point of the IRS reasonable compensation requirement is to prevent exactly what you're doing - minimizing payroll taxes.

I've heard the rule of thumb is at least 60/40 salary to distributions, so you're way off. You're basically paying yourself 21% salary and taking 79% as distributions.

Okay so what should I actually be paying myself? My accountant said $40k was fine because that's what the "market rate" is for someone with my experience in my area. But I do everything - sales, delivery, client management, invoicing, all of it.

If I increase my salary now, will that look suspicious to the IRS for this year?

A few things to consider:

Reasonable salary range: For an IT consultant generating $190k as the sole producer, I'd expect to see salary in the $80k-$120k range at minimum. You could use sources like:

The consequences of getting this wrong: If audited and deemed unreasonable, the IRS will:

I run a similar business - solo consulting S-corp. My CPA has me at about 55% W-2 and 45% distributions. She said that's conservative but defensible.

The way she explained it: imagine you got hit by a bus tomorrow and had to hire someone to do your job. What would you have to pay them? That's your floor for reasonable comp.

I was trying to do something similar to you (lower salary) and she basically said "Do you want to save $5k in taxes now or risk a $30k tax bill plus penalties in an audit?"

What about the 60/40 rule people talk about? Is that actually from the IRS or just a myth?

The 60/40 "rule" is not from the IRS - it's a rule of thumb some accountants use, but it has no legal basis. The IRS has never published a safe harbor percentage.

What matters is the actual facts and circumstances test. I've seen defensible cases with 50/50 splits and cases with 70/30 that got challenged. It depends entirely on your industry, role, and market rates.

The IRS published a fact sheet (FS-2008-25) that lists the factors they consider, but they deliberately don't give percentages because every situation is different.

Thanks everyone. This is really helpful and honestly pretty alarming. I'm going to find a new CPA who specializes in S-corps.

Based on the BLS data for my area and role, I'm going to bump my salary to $95k for the rest of the year and adjust my quarterly estimates. Better to pay the extra payroll tax now than deal with an audit later.

Smart move. And make sure your new CPA documents the compensation methodology in your corporate minutes. That contemporaneous documentation is your best defense if ever questioned.

Also consider looking at reasonable compensation studies or getting a formal compensation report if your revenue continues growing. For S-corps with significant income, it can be worth the $2k-$5k cost for the defensibility.