S-Corp Salary vs. Distributions | NJ Business Owner Guide

greg0036
4 hours ago
9 min read

If you’re a small business owner in Livingston, Short Hills, or anywhere in Essex County, NJ, you’ve likely heard about S-Corporations as a way to save on taxes. Running your business as an S-Corp can indeed cut your tax bill but only if you balance your salary and shareholder distributions correctly. Pay yourself too little salary and you risk IRS penalties; pay yourself too much and you might miss out on tax savings. In this guide, we’ll break down S Corp salary vs. distributions in plain English, with local New Jersey insights, so you can maximize benefits while staying compliant.

What Is an S-Corp and Why NJ Businesses Choose It

An S-Corporation (S-Corp) is not a type of business entity, but a tax election that many New Jersey small businesses use to reduce taxes. By electing S-Corp status with the IRS, your company’s profits “pass through” to your personal tax return instead of being taxed at both corporate and individual levels. For a business owner in NJ – whether you operate a boutique in Millburn or a consulting firm in Florham Park – this can mean big tax savings. Here’s why S-Corps are popular:

Avoiding Double Taxation: Unlike a regular C-Corp, an S-Corp generally doesn’t pay corporate income tax. Profits pass through to owners, so income is only taxed once (on your individual return).
Self-Employment Tax Savings: In a sole proprietorship or LLC, all business profit is subject to self-employment taxes (Social Security and Medicare). With an S-Corp, you split your income into salary and distributions. You pay payroll taxes (15.3% FICA) only on the salary portion, and the rest of the profit can be taken as distributions free of FICA tax. This is where the potential tax savings come in.
Liability Protection: If your business is an LLC or corporation that elects S-Corp status, you still get liability protection. Keeping formal payroll and accounting (required for S-Corps) can further reinforce that separation between your business and personal finances.

Local NJ context: New Jersey recognizes S-Corps for state tax purposes. As of late 2022, a federal S-Corp election automatically applies in NJ (no more separate state S-Corp filing). That simplifies things for NJ business owners. However, NJ S-Corps must still file a state S-Corp tax return and pay a minimum NJ Corporation Business Tax each year, ranging from $375 to $1,500 depending on your revenue. So while S-Corp status can save federal taxes, don’t forget the New Jersey side of the equation.

Salary vs. Distributions: Understanding the Difference

When your company is an S-Corp, the money you take out generally falls into two categories:

Salary (W-2 Wages): This is the portion you pay yourself as an employee of your S-Corp. You must run this through a payroll system, withholding federal and NJ income tax, Social Security, Medicare, etc. The S-Corp also pays the employer half of those payroll taxes. Salary is a business expense, reducing the company’s profit (and thus reducing pass-through income).
Distributions (Dividends): These are draws of profit you take as an owner. Distributions (sometimes called “owner draws” or “dividends”) are not subject to payroll taxes. They come out of the company’s after-expense profits and are recorded on a K-1 form for your personal tax return. You’ll pay ordinary income tax on S-Corp profits (whether distributed or not), but no FICA tax on distributions.

In simpler terms: Salary is treated like any employee paycheck (with taxes taken out), whereas distributions are like getting the profit that’s left in the company’s bank account (with no extra payroll tax taken). The tax advantage of an S-Corp comes from shifting some income from “salary” to “distribution” – thereby avoiding 15.3% self-employment tax on that portion. For example, if your NJ S-Corp has $100,000 of profit and you pay yourself a $60,000 salary, the remaining $40,000 can be taken as a distribution with no Social Security/Medicare taxes. That could save around $6,120 in taxes compared to being taxed as a sole proprietor.

However, this tax advantage only works if your salary is “reasonable.” You cannot just call 100% of your earnings a distribution to dodge payroll taxes – the IRS won’t allow that. This brings us to the crucial concept of reasonable compensation.

New Jersey business owner discussing S-Corp salary vs distributions with a CPA

IRS Rules: “Reasonable” Salary Requirement

The IRS requires S-Corp owner-employees to pay themselves a “reasonable compensation” as salary for the work they do. You must take a salary that is appropriate for your role, and you must pay payroll taxes on that salary. If you try to take all (or most) profit as distributions and little to no salary, the IRS can reclassify distributions as wages and hit you with back taxes and penalties.

IRS Crackdown: Courts have consistently ruled that S-Corp owners cannot avoid employment taxes by labeling compensation as distributions. In case after case, when owners paid themselves unreasonably low salaries, the IRS recharacterized the “tax-free” distributions as wages and assessed the unpaid payroll taxes plus interest and penalties. In short – if you’re doing work for your business, you need to pay yourself something reasonable for those services.

So, what is a “reasonable” salary? The tax code doesn’t give a hard number. It’s based on factors like:

Your Role and Duties: What would you have to pay someone else to do your job? If you’re a full-time manager in your business, and similar companies would pay $80k for that role, that’s a clue.
Industry Standards: Different industries have different typical salary levels. An owner of a small Roseland, NJ accounting firm might reasonably draw a different salary than an owner of a new restaurant in West Orange.
Business Profits: Your salary can’t exceed what the business can realistically pay, but it shouldn’t be too low relative to profit. For instance, if your S-Corp nets $300,000 and you only take a $20,000 salary, that’s a red flag. The IRS will ask how one employee could generate $280k in profit with only $20k of labor value – clearly, they’re likely to say the salary is understated.
Time Spent: Are you working in the business full-time or just a few hours a week? A part-time owner might justify a lower salary than someone clocking 60-hour weeks running the show.
Credentials and Experience: Your education and experience can affect what a reasonable compensation for your services would cost on the open market.

A common guideline some advisors use is the “60/40 rule” – pay yourself roughly 40%–60% of the profits as salary, and take the rest as distribution. However, this is NOT an official rule, just a starting point. The bottom line is to be able to defend your salary as something an independent business would pay for the work you do. It often helps to document how you arrived at your figure (e.g. citing salary surveys or industry reports).

Finding the Right Balance (Example)

Let’s illustrate with an example. Say you own a consulting S-Corp based in Livingston, NJ. After business expenses, your profit (before paying yourself) is about $120,000 for the year. You work full-time in the business providing the consulting services. What might be a reasonable salary?

You research and find that hiring a full-time consultant with your experience in NJ would cost around $70,000 per year. You decide to set your own salary at $70,000. You run payroll for yourself, which means:

The S-Corp will withhold federal and NJ income tax on that $70k and also withhold Social Security and Medicare (FICA) on it. You (as employee) and the company each pay 7.65% FICA on the $70k.
The $70k is a deductible business expense, reducing the company’s taxable profit.

Your company’s remaining profit after paying your salary is $50,000 ($120k - $70k). That $50k can be taken as a shareholder distribution. You’ll pay income tax on it on your personal return, but no FICA tax. By doing this, you’ve avoided payroll tax on $50,000 of earnings. In dollars, that saved you about $7,650 in Medicare/Social Security taxes (15.3% of $50k). Not bad!

Now, if you had tried to claim only a $20,000 salary and $100,000 as distribution – which is tempting to save more tax – you’d likely have trouble. A $20k salary for a full-time consultant is clearly too low. In an audit, the IRS could reclassify, say, $50k or more of that “distribution” as wages and demand back payroll taxes on it (plus penalties). That could wipe out any tax savings and then some. It’s not worth the risk.

CPA Tip: Don’t try to game the system with an unreasonably low salary. The IRS actively watches S-Corp owner pay. If you’re unsure what a proper salary is, consult a tax professional. It’s better to pay a bit more in payroll taxes upfront than to get hit with fines later. Remember, paying yourself a good salary isn’t just about taxes – it also helps you show steady income (useful for things like mortgage applications) and contributes to your Social Security for retirement.

Payroll Compliance for Your S-Corp Salary

When you do set a salary, make sure to run it through payroll properly. As the owner, you can choose to pay yourself monthly, biweekly, or even quarterly or annually, as long as you follow the rules. Each time you run payroll, your S-Corp needs to:

Withhold taxes and remit them to the IRS and NJ (just like any employer would for any employee).
File quarterly payroll tax returns (IRS Form 941 for federal withholding/FICA, and NJ state withholding filings).
Pay federal unemployment tax (FUTA) and NJ unemployment/disability taxes on your wages (typically relatively small amounts).
Issue you a W-2 at year-end summarizing your wages and taxes paid.

This is a lot of administrative work, but a good payroll service or bookkeeper can handle it. Many Essex County business owners use services like Gusto or ADP, or have their CPA manage the payroll. The fees are worth it to stay compliant.

Also, consider workers’ compensation insurance – in NJ, even owners on payroll may need to be covered by a workers’ comp policy (there are exemptions if you’re the only employee, but it’s something to check).

New Jersey Tax Tips for S-Corp Owners

Beyond federal rules, here are a couple of NJ-specific tips for S-Corps:

NJ S-Corp Election & Tax: As mentioned, NJ now automatically mirrors the federal S-Corp election. Just ensure your business is registered with the NJ Division of Revenue and Enterprise Services. Every year, file the NJ CBT-100S tax return for S-Corps and pay the minimum tax due. Even if your S-Corp makes little money, you’ll owe at least $375 to NJ in minimum corp tax (more if your gross receipts are high). Budget for this in addition to your personal NJ income tax.
Pass-Through Business Alternative Income Tax (BAIT): New Jersey introduced an optional “BAIT” program as a workaround to the $10k SALT deduction cap. In a nutshell, your S-Corp can elect to pay New Jersey income tax at the entity level, which your CPA can then deduct as a business expense, reducing your federal taxable income. The tax is then credited to your NJ personal return. This can be beneficial for owners of profitable S-Corps who pay high NJ taxes, effectively restoring the full federal deduction for those state taxes. The election is made annually (the deadline is typically March 15 of the following year for calendar-year entities). BAIT is complex, so discuss with a CPA if it makes sense for your situation – it’s not right for everyone, but it’s a clever tool that many NJ S-Corps (over 115,000 businesses statewide) are now using.
NJ Unemployment Tax: If you’re the only employee of your S-Corp, you might think you don’t need unemployment insurance. But in NJ, corporate officers are excluded from unemployment (and disability) coverage unless you specifically opt in. Many S-Corp owners choose not to pay NJ unemployment on themselves (since you’re unlikely to “fire yourself” and claim benefits). Talk to your payroll provider or CPA about filing an exclusion if applicable. This can save a bit on state payroll taxes.

By staying on top of these New Jersey requirements, you’ll avoid state-level issues and keep more of your hard-earned money.

Let a CPA Help You Get It Right

Balancing a reasonable salary vs. distributions is one of the most important tax decisions an S-Corp owner will make. It requires walking a fine line: you want to minimize taxes but not cross into risky territory. This is where having a CPA in your corner pays off. A knowledgeable CPA firm can:

Benchmark your salary: We’ll research your industry and region (hello, Essex County!) to suggest a salary range that the IRS would view as reasonable for someone with your duties.
Handle the paperwork: From initial S-Corp election filings to setting up payroll and preparing quarterly forms, a CPA or accounting service can take these compliance chores off your plate. (For instance, our Bookkeeping & Accounting team in Livingston can run your payroll and bookkeeping so you don’t have to worry about missed filings or due dates.)
Optimize your tax strategy: Perhaps you’re not sure if S-Corp is even the right choice, or if you should switch from an LLC. Through our Advisory Services, we help NJ business owners weigh entity options and tax strategies. We’ll also project your tax savings under S-Corp treatment and ensure you’re maximizing deductions (like health insurance for S-Corp owners, retirement plan contributions, etc.) as part of your overall plan.
Keep you compliant: No one wants an IRS or NJ tax notice. A CPA will help you avoid red flags (like an out-of-whack salary ratio) and keep all your records in order. If the IRS ever questions your compensation, you’ll have documentation and a professional ally to back you up.

Many small business owners in communities from West Orange to Roseland have found that the tax savings of an S-Corp are well worth it – especially when paired with the guidance of a proactive CPA. The key is to implement it correctly and review your salary annually. As your business grows, your reasonable comp might need to adjust.