Plan your expenses and deductions strategically each year
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Maintain accurate and organized financial records for easy reporting
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Talk to a tax professional for expert guidance
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Personalized Marketing: AI helps in analyzing customer data to create personalized marketing campaigns
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Use accounting and tax software to make management easier
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How to Legally Pay Yourself and Cut Taxes as a California S-Corp Owner
If you’re a California business owner running an S-Corporation, how you pay yourself isn’t just a bookkeeping decision — it’s one of the most important tax moves you’ll ever make.
A well-structured payroll strategy can save thousands of dollars in self-employment tax each year, while the wrong one can trigger IRS penalties or audits.
At PacificWestTax, we help business owners find the perfect balance between compliance and savings.
The Rule: “Reasonable Compensation”
The IRS requires S-Corp shareholders who actively work in the business to take a “reasonable salary” before drawing profits.
This rule ensures you pay employment taxes on a fair portion of income — but not on everything.
The challenge?
“Reasonable” isn’t defined by a single number. It depends on:
- Industry standards
- Time spent in the business
- Services performed
- Company profits and distributions
That gray area is exactly where strategic planning comes in.
Why This Matters in California
California has one of the highest state income taxes in the country — up to 13.3%.
On top of that, S-Corp owners pay:
- Federal payroll taxes (Social Security and Medicare) on salary
- A 1.5% California S-Corp tax on net income
- The state’s $800 annual franchise fee
Optimizing your mix of salary and profit distributions can mean the difference between overpaying by $10,000+ or staying fully compliant while minimizing taxes.
Example: Balancing Salary and Distributions
A Los Angeles marketing consultant earned $250,000 in net S-Corp income.
After benchmarking her role and workload, we set her salary at $110,000 — reasonable for industry standards — and took the remaining $140,000 as distributions.
Result:
- Paid payroll taxes on $110K only (not $250K)
- Reduced self-employment tax by roughly $17,000
- Passed IRS compliance review easily with proper documentation
Smart structure, clean books, no risk.
How to Determine a “Reasonable” Salary
Here’s a simple, defensible approach we use with clients:
- Review your job duties and time commitment.
- Research market salary data (industry, role, location).
- Match salary to a comparable W-2 employee in your field.
- Adjust based on profit margins and company cash flow.
- Document everything — IRS auditors look for clear records.
We maintain reference data for California industries, so our clients always have numbers to back up their salaries if questioned.
Common Mistakes S-Corp Owners Make
- Setting salary too low to avoid taxes — this can trigger an audit.
- Taking no salary at all — a clear IRS red flag.
- Not running formal payroll — draws and distributions don’t count.
- Overpaying salary — defeats the purpose of S-Corp savings.
- Ignoring California’s S-Corp compliance requirements.
Each of these can result in penalties, interest, or back taxes — all avoidable with proper structure.
How PacificWestTax Helps
Our team provides full S-Corp planning and support for California entrepreneurs:
- Benchmarking and salary analysis for “reasonable compensation”
- Payroll setup and compliance through trusted partners
- Distribution planning for cash flow efficiency
- Annual reviews to keep ratios in line as your business grows
We help business owners pay themselves strategically — not reactively.
Key Takeaways
- The IRS requires S-Corp owners to take a “reasonable salary.”
- Balancing salary and profit distributions saves thousands in self-employment taxes.
- California adds state-level taxes that make smart structuring critical.
- Proper documentation protects you during an audit.