Optimal Salary

Your S-Corp salary might be the most expensive “small decision” you make all year. Set it too low and you can lose deductions. Set it too high and you overpay payroll tax.

Key numbers

The core idea

Every strategy in this playbook is connected to the W-2 salary you pay yourself through the S-Corp. It's one single lever that determines how much you pay in payroll taxes, how much you can contribute to your 401(k), and how large your QBI deduction can be.

A higher salary means more payroll taxes, but it also means a larger employer 401(k) contribution (25% of W-2) and a higher QBI wage cap (50% of W-2). A lower salary means less payroll tax, but it shrinks your retirement contributions and your QBI deduction. Every dollar you shift in one direction helps one strategy and hurts another.

Yes, you need to set a reasonable salary to satisfy the IRS. But within that reasonable range, there's an optimal point where you minimize what you pay in payroll taxes while maximizing the benefit you get from your 401(k) and QBI deduction.

The 2/7 rule

A good starting point is the 2/7 rule. At 2/7 (about 28.6%) of total business income before wages, the math works out so that 50% of your wages equals 20% of your remaining QBI, meaning neither cap limits the other.

For example, at a $100,000 salary, payroll taxes would be just $15,300 and the 401(k) would total $49,500. But the 50% wage cap would hold the QBI deduction to $50,000, well below the full 20% of QBI. That's tens of thousands in deduction left on the table, costing far more in federal taxes than the payroll savings are worth.

At $200,000, you're much closer to the 2/7 target of $214,000, with far less deduction left on the table. The 401(k) maxes out at $72,000. Payroll is $13,378 more than the $100,000 salary, but the 401(k) gains $22,500 and the QBI wage cap doubles from $50,000 to $100,000. That's $72,500 more in total deductions for $13,378 in additional payroll cost.

The limitations

The 2/7 rule is a great starting point for finding your optimal salary, but it doesn't account for your entire tax picture. Your QBI is going to be affected by PTET, retirement contributions, and other business expenses, which will change where the two caps meet. This is a modeling exercise to revisit with your CPA every year as your income and deductions shift.