The S Corporation Owner Who Wants to Cut His Own Salary
Your client owns 100% of an S corporation consulting practice, which is a specified service trade or business. For 2025 the business will net roughly $520,000 before his W-2 salary, currently $80,000. He has read that lowering salary increases the Section 199A deduction and proposes cutting it to $40,000 and taking the difference as distributions. The couple files jointly; other income is $18,000 of interest. He also owns a condominium rented at $2,400 per month, which generates a $9,000 annual tax loss; $38,000 of prior losses are suspended. His wife is a licensed real estate agent who logs about 1,900 hours a year in brokerage, but she does not manage the condo, which a property manager operates. He wants three questions answered before year-end.
1. Evaluate the proposal to cut his W-2 salary from $80,000 to $40,000. Will it increase the QBI deduction?
Read the worked answer
No. It cannot help, and it creates real exposure.
Step 1 - character of the business. Consulting is a specified service trade or business. For an SSTB, the QBI deduction phases out entirely once joint taxable income exceeds the top of the phase-in range (roughly $394,600 of joint taxable income for 2025, plus the phase-in band). Their taxable income is roughly $450,000 or more. The QBI deduction is already zero. Reducing W-2 wages changes nothing, because there is no deduction to preserve.
Step 2 - what the salary cut actually costs:
- Social Security benefits: fewer covered earnings on his record.
- Retirement plan capacity: the employer contribution is keyed to W-2 compensation, so dropping to $40,000 cuts the maximum employer allocation by roughly half.
- Audit risk: $40,000 for a full-time consultant generating $520,000 of profit is not defensible reasonable compensation. Recharacterization to wages means back payroll taxes plus FICA penalties and interest, and the IRS can raise it on audit years later.
- It does not even save payroll tax cleanly, because the reasonable-compensation floor caps the gain.
Recommendation: leave the salary where it is or raise it toward a defensible market rate. Pursue the deduction where it does exist - retirement plan design and entity-level planning - not through a wage cut that buys nothing.
2. Can the $38,000 of suspended passive losses and the current $9,000 rental loss be used on this year's return?
Read the worked answer
Almost certainly not, on these facts. Rental real estate is passive per se unless a statutory exception applies. The only exception in play is the real estate professional rules, which require both:
- More than 750 hours and more than half of personal services in real property trades or businesses in which the taxpayer materially participates; and
- Material participation in each rental activity (or a valid grouping election).
The wife's 1,900 brokerage hours can satisfy the first prong - brokerage is a real property trade or business, and hours are aggregated across all such activities. But she does not materially participate in the condominium. A property manager runs it, and she performs no management. The 750-hour test is satisfied in a business she does materially participate in; the rental is not that business.
Result: the losses stay suspended. They are released when the property is sold to an unrelated party, or earlier if the couple generates passive income to absorb them.
If she wants the deduction: she must take over day-to-day management - tenant screening, leasing, repairs, capital decisions - and document hours contemporaneously, then make the grouping election on a timely filed return. Doing so converts all rental activities into one nonpassive activity, which cuts both ways: it frees the suspended losses but exposes future rental income to the 3.8% net investment income tax.
Do not claim the losses this year on a projected REPS position.
3. He wants to fund a $150,000 gift to his church with appreciated stock (basis $40,000) held in the brokerage account. What is the analysis?
Read the worked answer
Mechanics. A gift of long-term appreciated publicly traded stock to a public charity produces a deduction at fair market value and avoids the $110,000 of built-in gain. The deduction limit is 30% of AGI for capital gain property to a 50%-type organization - roughly $135,000 on a $450,000 AGI. $150,000 exceeds the limit; the excess carries forward five years.
Three fixes:
- Reduce the gift to the 30% ceiling this year and carry forward, or
- Split the gift - cash to the 60%-of-AGI limit for cash gifts plus stock, which lifts the deduction ceiling, or
- Bunch: fund a donor-advised fund with the stock this year, take the deduction up to the applicable limit, and grant out over several years. Bunching also concentrates deductions so it may push him past the standard deduction floor productively.
Check before executing:
- Confirm the shares are long-term (held over one year); short-term property is limited to basis.
- Confirm the church is a qualified 50%-type organization and get the written acknowledgment.
- Coordinate with the S corporation: the stock must be personal, not corporate, property. If the shares are inside the corporation, the corporation's deduction is limited to basis under Section 170(e).
- Verify AGI with the CPA; the 30% figure is computed on AGI, not taxable income.