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Most S-Corp owners have historically paid themselves the lowest salary the IRS will allow. The salary is subject to Social Security and Medicare taxes, but whatever profit is left avoids that surcharge.

Often, that is still a very legitimate strategy.

Often – not always.

Why is that?

Because of the up to 20% Qualified Business Income Deduction (QBI) and how it calculates. We emphasize “up to” because at higher income levels, the deduction starts to get phased out – and your salary can significantly impact how much of it you actually get.

So what is QBI and how does it work?

Pass-through entities (S-Corps, partnerships, sole proprietorships, and LLCs taxed as S-Corps, partnerships, or sole proprietorships) are eligible for a Qualified Business Income Deduction (QBI) of up to 20% on their profits. As an example, if your business had a $100,000 profit you could qualify for an up to $20,000 bonus deduction.

The major caveat to this is that at higher income levels the deduction gets phased out and is subject to a threshold of the greater of:

• 50% of the business’s W-2 wages or
• 25% of the business’s W-2 wages plus 2.5% of the business’s depreciable property (things like equipment, furniture, or buildings)

To give another example: imagine two companies each have $1,000,000 profit. Each company would be allowed an up to $200,000 deduction. Company A only has wages of $100,000 and Company B does not have any W-2 employees at all. Company A would only receive a $50,000 QBI deduction (50% of $100,000) and Company B would not receive any deduction at all (50% of $0).

There is also a second test: 2.5% what your business originally paid for depreciable assets like equipment or furniture (called UBIA in the tax code). For most service-based or light asset companies, it adds very little. For example, if both firms had $200k in equipment, Company A’s deduction stays $50k while Company B’s only bumps up to $5k.

Are you beginning to see instances where paying yourself too low of a salary can become problematic? Especially in instances where you do not have any other employees on payroll, the consequences can be significant.

How Salary Impacts Your QBI Deduction: Real Examples

We’ll get into the compliance side of this and some other considerations shortly, but first we want to run through some of the math on this to show just how significant those savings (or, if you don’t act, lost savings) can be.

Here’s how salary strategy can either trigger – or destroy – your QBI deduction at different income levels. We’re going to run QBI calculations at four income levels: $200k, $500k, $1 million, and $2 million. You’ll see how the higher the income gets, the more important this becomes.

For all of these scenarios we are assuming:

• No other sources of income outside of the business.
• No W-2 employees aside from the owner.
• Non-SSTB.
• Single filer.
• No dependents or other tax deductions/credits.

A few other important notes:

• The employer side of payroll taxes is a deductible business expense. For simplicity of illustrating how this works, we have not factored that into these scenarios. But the practical effect of this is that the scenarios with higher wages would actually be lower than what is shown here.
• These examples assume that the QBI deduction is not limited by the taxable-income cap under 199A(a)(2), which reduces taxable income by the amount of net capital gain.

Scenario 1: $200k Profit – Below the QBI Phaseout Threshold, Salary Doesn’t Matter (Yet)

For the first scenario, we’re taking a company with $200k profit and seeing what tax bill looks like depending on how much the owner pays themselves in salary – no salary at all, a W-2 of $50k, and a W-2 of $100k. Note: these figures have been rounded to the nearest thousand dollars.

At this income level, the lack of a salary doesn’t hurt you from a QBI perspective. You’re still under the phase-out threshold, so the full deduction is available either way. With that said, two big caveats:

• From a compliance perspective, you’re still required to pay yourself a reasonable salary.
• You need to have “earned income” like a W-2 to contribute to 401ks and other retirement accounts. S-Corp profits do not count as earned income. If you aren’t paying yourself a salary (or are paying too low of a salary), you’re hamstringing your ability to contribute to retirement and get the additional tax benefits that come from that.

While QBI isn’t affected at this level, that doesn’t mean that $0 of wages is a good idea.

That QBI calculation changes very quickly as your income increases, so let’s look at $500k.

Scenario 2: $500k Profit – Deduction Gone Without Wages, But Adding Salary Unlocks Huge Benefits

Now, you’re starting to see the phase-out triggering. At $0 of wages, the owner does not get any QBI deduction, even though they in theory are entitled to $100k.

And importantly – even though traditional wisdom would dictate that a lower salary = lower taxes, that ceases to be true in this situation. The lower salary (and the corresponding loss of QBI) costs them nearly $25k more in federal tax. Even when accounting for the payroll taxes, this shareholder is saving a net of $2k.

That doesn’t sound like much, but there are a few really important things to note:

• While the ultimate benefit we will receive from Social Security often seems unclear, we will receive something. All other things being equal, it’s better to contribute to Social Security vs. just paying income tax. This person contributed $19k into Social Security. If the system stays in place as it exists now, that will be several thousand dollars a month they will receive come retirement age. That’s a lot better than just paying the money in the form of federal income tax.
• You are required to pay yourself a reasonable salary from your S-Corp. Failure to do so can result in IRS audit and the IRS recategorizing your distributions as wages – along with costly penalties.
• Not having a W-2 means you can’t contribute to retirement accounts like a 401(k) or SEP.

Even with the somewhat most bottom-line savings, this person is still much better off than the person who took no salary at all. This only increases as income ramps up and the phase-out really starts to sting:

Scenario 3: $1M Profit – Strategic Salary Planning Starts to Snowball

This person is saving $20k even after accounting for Social Security and Medicare – and before accounting for additional deductions for retirement accounts, which any entrepreneur at this level would be making.

Scenario 4: $2M Profit – Optimizing Salary Can Save Over $60k in Tax

At $2M profit this person is saving $65k – again, before deductions for retirement. All while reducing IRS scrutiny by paying a more reasonable salary vs. the person trying to keep it low in the name of “saving money”.

Why Most CPAs Miss This QBI Strategy

Do you see what a powerful tool this can be for people in the right circumstances? We’re not exaggerating when we say it can literally save hundreds of thousands of dollars for very high earners. And this isn’t some obscure loophole – it’s a mainstream tax provision, built directly into the code.

Yet many CPAs still overlook this.

Why?

One justifiable explanation is that for many businesses, it simply doesn’t matter. QBI limitations only apply above certain income thresholds. Because the 50% of wages threshold is based on all W-2 wages – not just the shareholder’s – companies with large payrolls often qualify without even trying. So most CPAs aren’t thinking about it – and even fewer are modeling it out.

There’s also a deeper issue. A lot of CPAs focus on compliance, not planning. Their job – as they see it – is to prepare the return, not proactively find tax savings. If something isn’t being flagged by their tax software, it’s not even on the radar.

Even if they do offer planning, they can get stuck in their ways. So many still default to the old rule of “pay yourself the lowest reasonable salary” without ever reevaluating whether that still makes sense. QBI changed the rules in 2018, but a lot of CPAs treated it as temporary. And to be fair, it was. Until the OBBBA passed and made it permanent, the deduction was set to expire after 2025. A lot of CPAs simply ignored it, viewing it as temporary and not worth learning how to plan around.

Instead, they stuck with what they’d always done, assuming that repetition was proof it was right. Meanwhile, S-Corp owners in the QBI phaseout range are leaving tens of thousands of dollars on the table.

That doesn’t mean your CPA is bad. However, if they’re not actively modeling your salary strategy in light of QBI – and especially if you’re in the income ranges we covered here – they’re not doing real planning. They’re just filing returns.

Whether it’s due to inertia, lack of expertise, or simple unawareness, most CPAs still aren’t building QBI optimization into their planning for clients. This is unfortunate – because for those in the right position, it can be one of the most powerful tax strategies available.

What Counts as a Reasonable Salary for an S-Corp Owner?

One thing we want to be clear on here is that these examples are meant to be illustrative, not prescriptive. The IRS has specific criteria for determining a reasonable salary based on the work you perform – and “QBI optimization” isn’t one of them. We can’t just say “oh, $50k is the sweet spot for taxes, so that’s what my salary will be.”

What you pay yourself still needs to make sense for your position and the duties you perform. If you’re looking for help, we wrote an in-depth guide on reasonable compensation, how the IRS looks at it, and the factors to consider to stay compliant.

What counts as reasonable can vary – especially for owners wearing multiple hats. And where a salary range is justifiable – especially in those instances where increasing your salary saves you money (since most challenges are related to unreasonably low wages) – it’s irresponsible for us to not run the numbers and see what the most tax-optimized approach would be.

QBI Limits for SSTBs: What High-Income Professionals Need to Know

All of the businesses in the scenarios above were not considered SSTB (Specified Service Trade or Business). The IRS defines an SSTB as:

“Any trade or business providing services in the fields of:

• Health; Law; Accounting; Actuarial science; Performing arts; Consulting; Athletics; Financial services; Brokerage services; Investing and investment management; Trading or dealing in securities, partnership interests, commodities; or
• Any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners, as demonstrated by:
  • Receiving fees, compensation, or other income for endorsing products or services;
  • Licensing or receiving fees, compensation or other income for the use of taxpayer’s image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual’s identity; or
  • Receiving fees, compensation, or other income for appearing at an event or on radio, television, or another media format.”

SSTBs face stricter QBI limits. At lower incomes, they still qualify for the full deduction – but that phases out quickly. At income levels of ~$200k for single taxpayers and ~$400k for married couples filing jointly, QBI begins to be phased out regardless of the company total W-2 wages. For 2018-2025 the phase-in range is $50k for single filers and $100k for MFJ – increasing to $75k and $150k beginning in 2026.

In short: optimizing your salary will not help with QBI if you are an SSTB and your income is in those phase-out ranges.

There’s one more advanced strategy that may apply in high-income, low-payroll situations.

Contractors vs. Employees: QBI Tax Strategy Implications

Typically, businesses prefer independent contractors over employees because it reduces payroll taxes, administrative overhead, and benefits expenses. In fact, many businesses mistakenly classify workers as contractors when they legally should be employees – a practice the IRS scrutinizes through initiatives like the Voluntary Classification Settlement Program (VCSP).

However, if you run a high-income business that’s hitting the wage limit for the QBI deduction, reclassifying certain contractors as employees may actually reduce your tax bill. This represents one of the rare scenarios where converting contractors to employees can make sense purely from a cost standpoint.

Note: This is a highly specialized situation. Generally, the additional costs of payroll taxes and employee benefits outweigh any potential tax savings from increased QBI deductions. But if the business is already needing to add wages because of the QBI phaseout – and especially if some of your contractors should likely be employees anyways – this strategy is worth exploring.

Final Thoughts: Use QBI Salary Planning to Save Tens or Hundreds of Thousands

QBI optimization can be a somewhat niche strategy, but in the right circumstances it is an incredibly powerful tool. In the right scenario it can save tens – or even hundreds – of thousands of dollars, but it’s not a simple plug-and-play tactic.

It’s a complex strategy that needs to be done very carefully. Salaries must be justifiable under IRS rules. Certain industries (SSTBs) do not qualify, and in very specific cases, converting contractors to employees may make sense.

Done right – with help from a CPA who understands the nuance – it’s one of the most powerful tax strategies available. Done wrong, it can backfire and cost far more than it saves.

FAQ

Any accounting, business, or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.