S corp salary, the QBI deduction, and overtime reporting for contractors

Many trade owners switch to S corporation status to save self-employment tax. The savings are real, but they depend on setting salary correctly, and salary also affects your qualified business income deduction.

How the S corp saves tax

For a sole proprietor, 92.35% of net profit is subject to 15.3% self-employment tax up to the Social Security wage base, which is $184,500 for 2026, and to 2.9% Medicare tax above it. A 0.9% Additional Medicare Tax also applies above $200,000, or $250,000 for joint filers. In an S corp, only W-2 wages bear payroll tax, and distributions do not.

On $200,000 of profit, paying a $90,000 salary instead of running everything through Schedule C saves roughly $14,500 a year in payroll taxes. That figure comes before the added payroll and return costs and the smaller QBI deduction discussed below.

What counts as a reasonable salary

The IRS expects you to pay yourself what the business would pay someone else to do your job. For a working owner who runs service calls, estimates jobs, and manages techs, look at local wage data for a lead technician plus an operations manager. Document the analysis each year. A $30,000 salary on $300,000 of profit is a pattern that draws audits.

Key numbers: QBI deduction permanent at 20% · Social Security wage base $184,500 · overtime deduction up to $12,500, or $25,000 joint · employee tip and overtime deductions phase out above $150,000, or $300,000 joint.

How salary affects the QBI deduction

The 20% qualified business income deduction is now permanent. Construction trades are not specified service businesses, so the deduction isn't phased out by income type. Above the taxable income threshold, however, it is limited to the greater of 50% of W-2 wages or 25% of wages plus 2.5% of qualified property.

This has two practical consequences:

• Owner salary reduces QBI, because the salary itself isn't QBI, but it can increase the wage limit.
• Employee wages and equipment you own count toward the limit, so a contractor with a payroll crew rarely hits the cap.

Employer reporting for the overtime deduction

For 2025 through 2028, employees may deduct the premium portion of FLSA-required overtime (the "half" in time-and-a-half), up to $12,500, or $25,000 for joint filers, with phase-outs at higher incomes. Employers must report qualified overtime separately. For 2026, it goes on the W-2 in box 12, code TT. Your payroll provider should track the FLSA-required premium separately from other premium pay, because extra premiums under state law (such as California daily overtime), union or prevailing-wage agreements, or weekend differentials don't qualify.

In Connecticut

Connecticut has no QBI-style deduction, and the federal overtime deduction doesn't lower Connecticut tax either. The state return starts from federal adjusted gross income, and both deductions come after that line. For S corps, Connecticut instead offers an optional pass-through entity tax, elected each year on a timely filed return. The company pays 6.99%, owners get a refundable credit for 87.5% of it, and the payment is deductible federally outside the SALT cap. The Connecticut contractor guide shows when the election pays off.

A worked example

A plumbing S corp nets $320,000 before owner pay and has $600,000 of employee wages. The owner takes a $110,000 salary. After the S corp's share of payroll tax on that salary, QBI is about $201,600, and the 20% deduction is about $40,300, well within the wage limit. Compared with a sole proprietorship, payroll tax savings run around $14,600, or more if the 0.9% Additional Medicare Tax applies.

Common mistakes

1. Taking distributions all year and running payroll once in December.
2. Forgetting to run owner health insurance through payroll as W-2 wages.
3. Treating all premium pay as "overtime" for the employee deduction.
4. Electing S status without updating state payroll and franchise tax registrations.

How Summer Associates helps

Summer Associates prepares reasonable compensation studies, sets up owner payroll, and models how salary changes your QBI deduction and retirement contributions together.

This guide is general education based on federal and Connecticut law as of 2026-11-15. State rules differ and facts matter. Before acting, get advice for your situation from Summer Associates or another qualified advisor.