Reasonable compensation comes before distributions
Once an agency elects S corporation status, the owner who runs it becomes an employee of their own company in the eyes of the IRS. That means a real W-2 salary, run through payroll with withholding, is mandatory for any owner actively working in the business, and it must come before profit distributions. The standard is reasonable compensation: roughly what you would have to pay someone else to do the jobs you actually do, account direction, strategy, sales, operations, at market rates for your experience and hours.
There is no official IRS table, but there is a defensible method: look at salary data for the roles you fill, weight by how you spend your time, and document how you landed on the number. An owner billing high-level strategy full time cannot credibly pay themselves a token salary; an owner who has genuinely stepped back to a few hours a week can justify a lower one.
The payroll tax math on agency profit
The reason the salary question matters is the 15.3% that funds Social Security and Medicare. Salary bears it (split between employee withholding and the employer side, both ultimately funded by your agency). Distributions do not. So an agency with $250,000 of profit paying its owner a $110,000 reasonable salary runs payroll tax on the salary only; the remaining $140,000 passes through on the Schedule K-1 free of self-employment tax. Compare that to a sole proprietorship, where the entire profit is exposed, and the annual savings become the whole argument for the S corp.
That same math is why the IRS polices lowball salaries. An agency owner taking a $20,000 salary against $300,000 of distributions is the classic audit profile, and the downside is ugly: reclassified distributions, back payroll taxes, penalties, and interest. The savings are real when the salary is defensible; they evaporate when it is not.
Form 2553 on time, and whether the trade is worth it
The election itself is Form 2553, generally due within 2 months and 15 days of the start of the tax year you want it to apply to, though the IRS grants late-election relief routinely when requirements are met. Electing brings obligations: a payroll system filing quarterly employment returns, a W-2 each January, and a separate Form 1120-S business return.
Those obligations cost real money, typically a few thousand dollars a year in payroll and tax prep. The break-even logic is simple: the election wins when 15.3% of the profit you can legitimately take as distributions comfortably exceeds those added costs. For an agency clearing well into six figures of profit with a reasonable salary that leaves substantial distributions on the table, the answer is usually yes, take the salary and the election. For an agency whose entire profit is roughly what a reasonable salary would be anyway, there is nothing left to distribute and the election just adds paperwork.