Los Angeles S-Corp Tax Guide 2025: How ‘Reasonable Compensation’ and California Rules Shape Your Self-Employment Savings
- Gustaf Rounick, CFP®, ChFC®
- May 15
- 6 min read
Updated: Jul 22
The Allure of the Shortcut
Forming an S-Corporation is often pitched as an instant 15.3 percent* self-employment-tax savings. The pitch sounds simple: run your income through the S-Corp, call most of it a “distribution,” and avoid payroll taxes. In reality, the IRS expects every shareholder-employee to draw a “reasonable salary,” and the dollars you mis-classify can become the government’s best friend in an audit.
What Self-Employment Tax Covers
Self-employment tax is just Social Security and Medicare levied on business earnings. For 2025, the Social Security portion—12.4 percent combined employer–employee—applies to the first $176,100 of wages or net earnings.[1] (Social Security) The 2.9 percent Medicare portion has no cap; an extra 0.9 percent kicks in on wages or self-employment income above $200,000 for single filers and $250,000 for married couples.[2]IRS
The Reasonable-Compensation Gatekeeper
Because S-Corp profits pass to you without self-employment tax, Congress required shareholder-employees to pay themselves a salary that reflects what similar businesses would pay for comparable work. The IRS discusses this in its S-Corporation compensation fact sheet and routinely cites the rule in enforcement actions.[3] (IRS)
How the IRS Decides What’s “Reasonable”
Auditors examine industry surveys, geographic wage data, your education and experience, time spent in the business, profitability, and even the company's compensation practices for non-owner employees. Court cases such as Watson v. Commissioner illustrate the point: a CPA drew only $24,000 in wages on over $200,000 in profits; the court re-characterized $91,000 of the distributions as wages, triggering back payroll tax and penalties.[4] (Forbes)
The High Cost of Getting It Wrong
If your salary is deemed too low, the IRS can reclassify distributions as wages, assess payroll tax, tack on interest dating back three years (or more if fraud is alleged), and impose negligence penalties of up to 20 percent. Once flagged, your entity may be placed on a three-year examination cycle—hardly the “set-and-forget” strategy many entrepreneurs expect.
Paperwork, Payroll, and State Friction
Running an S-Corp means running payroll every pay period, filing quarterly Form 941s, issuing year-end W-2s, and preparing a separate Form 1120-S. States add their own layers. In California, every S-Corp pays the higher of $800 or 1.5 percent of net income as a franchise tax—even if the business loses money.[5]Franchise Tax Board
California-Specific Costs and Credits You Can’t Ignore
Minimum Franchise Tax
Every S-Corp doing business in California owes the higher of 1.5 percent of net income or an $800 minimum, due in the first quarter, even if you broke even.[5]FTB
Pass-Through Entity Tax (PTET) SALT Work-Around
Through 2025, qualifying S-Corps can elect to pay a 9.3 percent entity-level tax and pass a matching credit to shareholders, softening the federal $10,000 SALT cap. [8] (FTB-PTET) The first installment (the greater of $1,000 or 50 percent of last year’s PTET) is due June 15, and the balance is due with the March 16, 2026, return for 2025 income. [9] (FTB-3893)
Why It Matters in L.A.
Many Westside service firms clear six-figure profits but have few deductible expenses. Combining a fair salary with the PTET election can result in tens of thousands of dollars in federal deductions, if cash flow supports the June prepayment.
Savings Are Not Automatic
Assume your advisory firm nets $150,000. A market-rate salary might be $120,000. On that amount, you and the corporation owe the full 15.3 percent combined payroll tax up to the Social Security ceiling. Only the remaining $30,000 passes free of those taxes—a saving of roughly $4,590. Additionally, consider the ongoing payroll service, bookkeeping, corporate tax return, and state-entity fees. If your profits routinely fall below “reasonable pay,” the structure quickly becomes a drag.
Local Case File: Venice Design Co. (hypothetical illustration)
Profit: $180,000 in 2024
Reasonable salary benchmark: $125,000 (based on BLS data for “Art Director, L.A.-Long Beach-Anaheim”)
Tax outcome:
• Payroll tax on salary ≈ $19,125
• Remaining $55,000 passes free of self-employment tax—saving ≈ $8,415
• PTET election adds $16,740 entity tax but yields an identical state credit to the owner, restoring $16,740 of the lost SALT deduction federally.
Net result: After fees, the owner is $4,200 ahead versus operating as a sole prop—proof that the S-Corp “magic” appears only when salary, PTET, and cash timing all line up.
Don’t Forget Other Tax Knobs
Distributions from an S-Corp are not self-employment income, but they still inflate adjusted gross income and can make you subject to the 3.8 percent Net Investment Income Tax when other passive income exists.[7] (IRS) High wages, on the other hand, may reduce the Section 199A qualified-business-income deduction available to many sole proprietors. Balancing these moving parts is part art, part science.
Best Practices for Safe Savings
Document your salary methodology every year—think third-party wage studies, industry association surveys, and a written job-description grid. Revisit the amount whenever profits jump. Keep pristine corporate minutes, a separate bank account, and accurate basis schedules. Schedule K-1 instructions remind shareholders that losses and distributions are limited to basis and are not self-employment income.[6] (IRS)
Professional Advice Matters
DIY templates rarely capture the nuance of your workload, client mix, or state tax quirks. Engaging a CPA or Enrolled Agent who handles S-Corp reasonable-compensation studies can transform an audit risk into a defensible plan. A fee of a few thousand dollars upfront is a relatively inexpensive form of insurance compared to back taxes and penalties.
Key Takeaway
An S-Corporation can be a powerful planning tool, but it is not a one-size-fits-all hack. The real savings appear only after you (1) pay yourself a market-rate salary, (2) factor in state and administrative costs, and (3) coordinate the strategy with your broader tax picture. Treat the entity as a surgical instrument, not a magic wand.
People Also Ask: Los Angeles S-Corp Tax Questions
Do all California S-Corporations have to pay the $800 minimum franchise tax every year?
Yes. The California Franchise Tax Board requires every corporation incorporated, registered, or doing business in the state to pay the greater of 1.5 percent of net income or an $800 minimum—even during loss years.[10]
When are the PTET pre-payments due and how much must I send?
To make the Pass-Through Entity Tax election for 2025, you must remit the first installment by June 15. The amount is the greater of $1,000 or 50 percent of the PTET you paid for 2024; the balance is due with the 2025 S-Corp return filed by March 16, 2026.[11]
How does the IRS decide whether my S-Corp salary is “reasonable”?
The IRS compares your pay with industry norms for similar work in your region, the hours you devote, and your company’s profitability. Distributions that exceed a fair wage can be reclassified as salary and hit with back payroll tax during an audit.[12]
Can my S-Corp distributions be used to calculate Solo 401(k) contributions?
No. Only the W-2 wages you pay yourself as an employee count toward both employee deferrals and employer profit-sharing contributions. Distributions are not considered earned income for retirement-plan purposes.[13]
What payroll tax rates apply to S-Corp owner salaries in 2025?
W-2 wages are subject to a 6.2 percent employer and 6.2 percent employee Social Security tax up to the $176,100 wage base, plus 1.45 percent each for Medicare. An extra 0.9 percent Medicare surtax applies to wages above $200,000 (single) or $250,000 (married).[14]
Gustaf Rounick, CFP®, ChFC®
Work Cited
[3] https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues
[4] https://www.forbes.com/sites/anthonynitti/2012/12/06/the-top-ten-tax-cases-of-2012-4-s-corporation-shareholder-reasonable-compensation-how-much-is-enough/
*The 15.3 percent figure combines 12.4 percent for Social Security and 2.9 percent for Medicare.
[13] https://www.irs.gov/retirement-plans/retirement-plan-faqs-regarding-contributions-s-corporation
Disclaimer
Westlight Wealth (“Westlight”) is a California registered investment adviser located in Venice, California. Registration with the U.S. Securities and Exchange Commission or any state securities authority does not imply a certain level of skill or training. The information presented in this article is provided for educational and informational purposes only and is not intended as, and should not be construed to be, legal, tax, accounting, or investment advice.
All examples—including any case studies or illustrations—are hypothetical and are provided solely to explain general tax concepts; they do not represent actual client results. Tax laws, regulations, and rates may change without notice, and their application can vary widely based on specific facts and circumstances. You should consult with a qualified tax professional, attorney, or financial adviser who is familiar with your unique situation before acting on any information contained herein.
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