Understanding the Importance of S Corporation Shareholders' Forms W-2

S corporation shareholders can generally receive two types of income: W-2 compensation and pass-through distributions. In terms of employment taxes, treating income as distributions can be beneficial. The S corporation is also required to pay the shareholder "reasonable compensation" for their services. While it may be tempting to characterize more income as distributions, only W-2 compensation is counted in determining how much the individual is entitled to contribute to retirement plans. Contributions cannot exceed the individual's compensation for the year. Shareholders who are paying themselves too little in terms of traditional compensation may be limiting themselves when it comes to maximizing retirement account contributions (in 2026, owner-employees can contribute up to $72,000 when both the employer and employee-side contributions are considered--but not more than the employee's compensation). For more information on the rules governing retirement plans that cover S corporation shareholder-employees, visit Tax Facts Online. Read More: Link to Q3826.