Introduction
If you own an S-Corporation in California, the Franchise Tax Board (FTB) is watching how you pay yourself. In 2025, FTB and IRS audits are increasingly focused on reasonable compensation especially for founder-only businesses.
Paying yourself too little (or nothing) can lead to back payroll taxes, penalties, and misclassification audits.
This guide explains what counts as “reasonable compensation,” how to calculate it, and what to report on your California and federal returns.
IRC and California Code References
- IRC §1366 – Pass-through income from S-Corporations
- IRC §3121(a) – Employment taxes on wages
- IRS Fact Sheet FS-2008-25 – Reasonable compensation guidelines
- Cal. R&TC §19504 – California audit authority
- FTB Pub. 1060 – Corporate officer compensation
What is “Reasonable Compensation” for an S-Corp?
Reasonable compensation is the fair market value of the services you perform for your S-Corp. It must reflect:
- Your role (e.g., CEO, salesperson, operations)
- Hours worked
- Industry standards
- Revenue and profitability of the business
If you’re actively involved in daily operations, you cannot take all income as distributions a salary is required.
Example: Solo Founder Earning $180K Net Income
Example: Maya runs a digital agency through her California S-Corp. The company earns $180,000 net in 2025. She takes only $20,000 as W-2 salary and the rest as distributions.
FTB flags this during a review.
Adjustments made:
- IRS and FTB determine a reasonable salary would be $100,000
- Back payroll taxes (Social Security, Medicare, UI, ETT) assessed on the $80,000 difference
- Penalties and interest added
Step-by-Step: Complying with Compensation Rules in 2025
- Benchmark Industry Pay
Use sources like Glassdoor, BLS, or compensation surveys to determine what someone in your role earns. - Document Your Job Duties
Keep a record of what you do: sales, client work, product design, admin. - Set a Reasonable Salary
Adjust based on profits, hours worked, and your contributions. - Run W-2 Payroll
Use a service like Gusto or ADP to issue paychecks and file CA DE-9/DE-9C. - Avoid 100% Distribution Strategy
Split income between W-2 wages and distributions for tax efficiency.
Conclusion
S-Corp owners in California must pay themselves a fair salary in 2025. Underpaying invites FTB and IRS audits, penalties, and tax adjustments.
Avoid trouble set a documented, justifiable wage and run proper payroll.
Call to Action
Not sure how much you should pay yourself from your S-Corp?
Schedule a compliance check with Anshul Goyal, CPA, EA, FCA
Anshul helps:
- Determine market-based compensation
- Set up CA payroll and federal compliance
- Avoid FTB wage audits and late penalties
Don’t wait for an audit to fix your salary. Get compliant now:
https://calendly.com/anshulcpa/
Anshul Goyal, CPA, EA, FCA
Anshul brings 15+ years of U.S. and international tax experience. He specializes in helping online sellers, foreign founders, and U.S. residents with IRS and multi-state compliance. Known for his deep knowledge in Shopify and Amazon seller tax strategy, Anshul has helped hundreds of entrepreneurs minimize taxes and scale legally.
Disclaimer
This blog is for informational purposes only and does not constitute legal or tax advice. Please consult a qualified tax professional regarding your individual tax situation.
Top 5 High-Searched FAQs (2025)
1. What is a reasonable salary for an S-Corp owner in CA?
It depends on your role, hours, and industry pay benchmarks.
2. Can I take all S-Corp profits as distributions?
No. You must take a salary first if you work in the business.
3. Will CA audit my compensation amount?
Yes, especially if W-2 wages are unusually low.
4. How do I calculate payroll taxes in CA?
Use SDI, UI, ETT, and PIT formulas per EDD.
5. Is Gusto or ADP required for payroll?
No, but using payroll software ensures timely reporting and payments.