How S Corp Tax Savings Actually Work
Most of what you hear about S-corp "15 percent tax savings" is wrong or oversimplified.
If you're an owner-operator, here's how it really works.
1. Why S-corps save tax in the first place
If you're a sole prop or single-member LLC (taxed as a disregarded entity), all your business profit is exposed to self-employment tax:
• 12.4% Social Security
• 2.9% Medicare
• Applied to 92.35% of your net profit (the law lets you deduct the "employer half" inside the formula)
Effective rate:
15.3% × 92.35% = 14.13% of profit
Social Security is only charged up to the wage base:
• 2025 wage base: $176,100
• 2026 wage base: $184,500
Above that, only Medicare applies:
2.9% × 92.35% = 2.678%
That's the real math.
An S-corp changes the game by letting you split business income into:
• W-2 wages to you (subject to payroll tax), and
• K-1 distributions (not subject to payroll tax)
Your job as the owner is simple:
Keep the W-2 piece as low as you can, while still being an amount that is clearly "reasonable" to the IRS.
2. QBI is the thing everyone forgets to mention
Another thing to consider when deferming the W-2 piece is how it interplays with the Qualified Business Income (QBI) deduction of up to 20% of business income.
For an S-corp owner:
• QBI is generally your K-1 ordinary business income (after expenses)
• W-2 wages to you do not create QBI
• If you move $1 from K-1 to W-2, you:
• Lose QBI on that $1
• Add payroll tax on that $1
But if your taxable income is high enough, there's a catch:
The QBI deduction can be limited by wage rules:
Your QBI deduction is capped at the greater of:
• 50% of W-2 wages from the business, or
• 25% of W-2 wages + 2.5% of certain property
Why the "OR"?
Because the law gives a second formula for capital-heavy businesses.
For service-based S-corporations with little depreciable property, the 50% of wages number is what matters in practice.
If your W-2 is too low once you're over the income thresholds, those formulas can choke down the QBI deduction.
So the balancing act is:
Pay just enough W-2 to keep QBI intact, but not so much that you're lighting payroll tax and QBI on fire.
3. There is no magic salary number or percentage
Everyone wants a single "safe" S-corp salary number.
There isn't one.
In practice, for an active owner actually working in the business, the mathematically optimal point under the classic one-owner S-corp model is:
W-2 wages subject to FICA = 28.572% of business profit
(this exact point assumes the owner is the only W-2 employee; in real businesses the optimal percentage can be much lower or much higher depending on wages paid to others and reasonable-comp factors, though many owner-operators still land somewhere in the 28–35 percent zone)
• Below that, at higher incomes, the QBI wage limits start to become a real risk
• Above that, you're giving up:
• payroll-tax savings, and
• QBI,
for no added benefit
This 28-35% range is not a legal safe harbor. It's a planning result where the math works out best under standard conditions.
4. "Reasonable comp" is not just your salary
Most people, including overly conservative tax preparers, talk about "reasonable comp" like it's just the base salary that ends up in Box 1 of your W-2.
That's not how the IRS looks at it.
They look at your total compensation package, which includes more than just base pay.
The key for S-corp owners is this:
Some items count toward compensation for optics,
but do not increase FICA the way more salary does.
A. Items that go on W-2 but avoid FICA (huge leverage if set up correctly)
For >2% S-corp shareholders, when structured properly under a plan:
• Shareholder health insurance (SEHI)
• HSA contributions paid by the S-corp
• Long-term care insurance (LTCI) premiums
These are:
• Included in Box 1 wages for income tax
• Not subject to Social Security or Medicare (no FICA)
• Deductible by the S-corp as compensation
So they:
• Make your compensation look higher
• Help with "reasonable comp"
• Do not increase payroll tax
They do slightly reduce QBI, but only because they are normal business expenses that reduce profit. That impact is usually small compared to the payroll-tax cost of pushing the same dollars into straight W-2 wages.
B. Items that don't hit W-2 but still strengthen the package
These do not increase FICA and don't show up as W-2 wages, but they clearly add to what you're getting out of the business:
• SEP employer contributions
• SIMPLE employer contributions
• Solo 401(k) employer contributions
• Accountable plan reimbursements (mileage, home office, etc., done properly)
For "reasonable comp" optics, the IRS will look at everything you receive in exchange for services, not just salary.
Your real move is:
Use these benefits to make your overall package look strong, while keeping actual FICA-wages as low as defensibly possible.
5. The S-corp owner compensation blueprint
For an owner-operator, the playbook looks like this:
- Pick a defensible W-2 number
• Start by looking at market pay for what you actually do
• Check where that lands as a percentage of profit
• Aim to be roughly in that 28–35% of profit corridor unless facts clearly push you higher or lower - Layer in FICA-free W-2 items
• SEHI
• HSA contributions from the S-corp
• LTCI
These increase "comp" without increasing Social Security and Medicare tax. - Add non-W-2 total-comp items
• SEP / SIMPLE / Solo 401(k) employer contributions
• Accountable plan reimbursements
These strengthen your position that you're being reasonably compensated for what you do. - Push the rest of the profit to K-1
• No payroll tax
• Eligible for QBI (subject to normal rules)
• Better after-tax yield than wages - Watch the QBI rules at higher income levels
• Make sure W-2 isn't so low that the wage formulas start capping your QBI deduction
• But don't raise W-2 beyond what you need to:
• stay factually reasonable
• avoid choking down your QBI deduction
The bottom line
S-corp tax savings are not "15% on everything."
They come from coordinating:
• FICA on wages
• The QBI deduction
• The Social Security wage base
• And the full picture of what counts as "compensation," not just salary
In practice, the game is:
Use the lowest defensible W-2,
stack FICA-free and tax-efficient benefits on top,
and let the rest flow as K-1.
That's the real S-corp salary strategy.
What’s Next?
Salary is just the beginning. There are dozens of ways to expand S-corp planning that most owners never hear about — until they see what's actually possible.
If you want help applying these strategies to your own situation, reach out to us.
Disclaimer: This is general information, not tax advice. S-corp planning is fact-specific and the right strategy depends on your numbers, your role in the business, and how your compensation is structured. Work with a professional who understands your exact situation before making changes.