How to Pay Yourself as a Profitable Contractor: Salary vs. Distributions in 2026

If your trade business is an LLC or S-Corp and it is finally throwing off real money, here is the short answer on how to pay yourself: run payroll for a reasonable salary, then take the rest as distributions. The salary carries payroll tax. The distributions do not. That split is where the savings live, and it is also where the IRS looks first.

The trap most contractors fall into is paying themselves too little on paper to dodge tax, or paying themselves nothing at all. Both get unwound in an audit. The right move is to set a defensible wage, document why, and take what is left as a distribution. Below is exactly how to land on that number, with the cases and the math.

This post is part of our broader contractor tax planning hub, where we walk through structure, deductions, and cash flow for the trades.

What does it mean to pay yourself as an S-Corp versus an LLC?

How you pay yourself depends on your tax classification, not your logo. A single-member LLC that has not made an S election is taxed as a sole proprietor: there is no such thing as a paycheck to yourself. You just take an owner's draw, which is a transfer of money from the business to you, and you owe self-employment tax on all of your net profit.

Self-employment tax is the 15.3% Social Security and Medicare tax that a sole proprietor pays on business profit, standing in for the payroll tax an employer and employee would otherwise split. On a plain LLC, that 15.3% hits every dollar of net profit up to the Social Security wage base of $184,500 in 2026, and the Medicare portion keeps going with no cap above that.

An S-Corp is different. An S-Corp is a tax election, a status your LLC or corporation applies for that changes how the profit is taxed. Once you are an S-Corp, you become an employee of your own company. You pay yourself a W-2 salary through payroll, which carries the same 15.3% split between you and the company, and then you take the remaining profit as a distribution, a payout of company earnings to the owner. That distribution is not subject to the 15.3%. That is the whole reason contractors elect S-Corp status, and it is why the salary number matters so much. If you want the full comparison, we lay it out in LLC vs. S-Corp for contractors.

How much should I pay myself as a salary?

Pay yourself what someone would charge to do your job. In our experience a reasonable S-Corp salary lands around one-third of net profit for most owner-operators, but that is a starting point, not a law. The real standard is market pay for the work you actually do, and the number has to hold up if someone reads your file.

The anchor case here is Watson v. United States, decided by the Eighth Circuit in 2012. David Watson was an Iowa CPA with twenty years of experience who paid himself a $24,000 salary out of a firm that was sending him roughly $175,000 to $200,000 a year in distributions. The IRS said the $24,000 was a fiction, and the court agreed. What is useful for you is how the court fixed the number: it did not guess. It pulled AICPA salary-survey data for someone in Watson's role and set his reasonable compensation at $91,044, then let the IRS collect payroll tax on the difference between what he paid himself and what the market said the job was worth. You can read the opinion here.

Copy the court's method and you are safe. Look up what a foreman, a lead installer, or a general manager earns in your trade and your region, write one honest paragraph explaining the number, and keep it in your file. A roofing contractor who runs crews, bids jobs, and manages the office is not paid like a laborer, and the survey data reflects that. Set the wage the way Watson did and the number is defensible.

Can I just pay myself zero salary and take everything as a distribution?

No. If you do real work in the business, a zero salary never survives. The IRS will reclassify your distributions as wages, then add back the payroll tax you skipped, plus penalties and interest.

That is exactly what happened in Radtke v. United States, out of Wisconsin in 1989 and affirmed by the Seventh Circuit in 1990. A lawyer paid himself a $0 salary and pulled everything out as dividends. The court looked at the substance, not the label, and called the dividends what they were: wages for services. The lesson is blunt. If you are on the tools, on the phone, or on the jobsite, the business has to pay you a wage before it pays you a distribution. Zero is not a strategy.

How much should I take as a distribution?

Whatever is left after a reasonable salary and after you have set money aside for taxes. Once the wage is defensible, the distribution is the reward for owning the business, and it comes out free of the 15.3% payroll tax. Here is the sequence with real numbers.

Say your HVAC S-Corp nets $180,000 in profit before your pay in 2026. You look up market pay for an owner who runs crews and the office, and you land on a $70,000 salary, a little under our one-third rule of thumb but well supported by survey data. You run that $70,000 through payroll. The company and you together pay 15.3% on that wage, which is about $10,710 in Social Security and Medicare tax. That leaves $110,000 of profit. You take that $110,000 as a distribution, and none of it carries the 15.3%. Now compare that to a plain LLC with no S election. On the same $180,000, self-employment tax runs 15.3% up to the $184,500 wage base, roughly $25,000 before the small above-the-line deduction. The S-Corp split saves you well over ten thousand dollars on this one year, and it repeats every year the profit holds.

The catch is that the distribution is not tax-free, it is just payroll-tax-free. You still owe income tax on the full $180,000 of profit whether you call it salary or distribution, because an S-Corp passes its profit through to your personal return. So do not spend the whole distribution. Set aside 25% to 30% of every net dollar for taxes, and in California make it 30% because of the state's rate on top. We break the mechanics down in how much to set aside for taxes.

Is a low salary always better?

No, and this is the part contractors get backwards. The legal standard is "reasonable," not "as low as possible." A salary that is too low invites the IRS to reclassify distributions as wages. But a salary that is genuinely high because the work is genuinely valuable is completely fine, and the IRS loses when it argues otherwise.

Look at H.W. Johnson, Inc. v. Commissioner, a Tax Court case from 2016 involving an Arizona concrete contractor. The company paid two brothers officer compensation of $4 million and $7.3 million. The IRS called it unreasonable and tried to knock it down. The Tax Court upheld every dollar, because the brothers ran daily operations, drove the company's growth, and the pay matched what they contributed. That case is the mirror image of Watson. The point is not that low is safe and high is dangerous. The point is that the salary has to match the work. If you are the reason the business runs, a strong salary is defensible; if you are barely involved, a small one is fine. Match the number to reality and document it either way.

When is it even worth switching from an LLC to an S-Corp to do this?

Run the S-Corp math once your net profit clears roughly $80,000 to $100,000 and looks like it will repeat. Below that, the payroll-tax savings often do not cover the cost of running payroll, filing a separate return, and, in California, the $800 franchise tax that S-Corps owe every year after their first.

The reason there is a threshold is that the S-Corp only saves you money on the profit above your salary. If your whole net profit is $50,000 and a reasonable salary for your role is $40,000, there is almost nothing left to take as a low-tax distribution, so the election buys you very little and costs you setup and upkeep. Once the profit is comfortably above what your job is worth, the gap between salary and profit widens and the savings become real. We cover the timing signals in when you should become an S-Corp, and we dig into the self-employment tax math in self-employment tax for contractors.

One more piece for California owners: a new S-Corp is exempt from the $800 franchise tax in its first taxable year, but an LLC is not, because the first-year LLC waiver expired after 2023. So a California contractor forming an LLC today should expect the $800 from year one. Budget for it.

How do I actually run the salary through payroll?

Set up a payroll system, put yourself on it as a W-2 employee, and pay yourself on a regular schedule, whether that is monthly, twice a month, or quarterly. The system withholds the Social Security and Medicare tax and your income-tax withholding, files the payroll returns, and issues you a W-2 in January. This is not optional paperwork; it is what makes the distribution defensible, because the salary has to actually run through payroll to count as a salary.

Distributions are simpler. You move money from the business account to your personal account and record it as a distribution in your books. There is no withholding on a distribution, which is exactly why you have to handle the tax yourself. That is where the estimated-tax system comes in: because no one is withholding on your distributions, you send the IRS and California quarterly payments to cover the income tax on your pass-through profit. Hit the safe harbor by paying in 90% of this year's tax or 100% of last year's, and 110% of last year's if your prior-year adjusted gross income was over $150,000, and you avoid the underpayment penalty. If you end up owing under $1,000, there is no penalty at all.

A common question is whether the salary counts toward retirement contributions, and it does. Your W-2 wage is what a Solo 401(k) or SEP-IRA contribution is measured against, and those plans let you put away up to $72,000 in 2026 depending on the setup. So a reasonable salary is not just a tax cost, it is also what unlocks a big deductible retirement contribution. That is another reason not to lowball the wage into the ground.

The whole game is one balance: a salary high enough to be defensible, and a distribution large enough to be worth the effort. Set the wage the way the courts do, run it through real payroll, take the rest as a distribution, and hold back 25% to 30% for the income tax that follows the profit no matter what you call it. Do that and paying yourself stops being a guess.

Not sure your salary number would hold up in an audit? We set defensible reasonable-compensation figures for trade contractors using market data, run the S-Corp savings math, and keep the documentation on file so the number is ready before anyone asks. Book a meeting with our team here.