IANAA, but I pay one every year.

S-Corp is not an efficient entity type for a windfall like this. It is a pass through entity, and cannot retain earnings year over year, for that you need a C-Corp.

That said, had they already had a C-Corp set up, then this income would be taxed at 21%, so after Steam fees and taxes, they would be sitting on around $3.3M (not counting publisher fees and any expenses that might arise). If they hold that money for 120 days, they can then do regular monthly dividend distributions of around $7k, and it would be considered tax free to their person (assuming married, and no other source of income), but keep in mind they already paid 21% taxes on it. Any amount above that would be taxed at 15% (then 20% at top tax bracket), so if they wanted $200k/yr, that would be a monthly dividend of around $17k, 7k of that is "tax free" then the other 10k would be taxed at 15%. But again, they pre-paid 21% taxes at the c-corp level, so 15% would actually be 36%, which is nearly top tax bracket already, and it was hit MUCH sooner than if you took a higher paid salary.

It's a good thing you pay an accountant...

What you suggest is not a hack of the tax code. Close corporations are generally required to pay reasonable salaries to their owners (and more importantly, payroll taxes on those salaries) if the corporation's revenue is derived from the labor of its owners. Not doing this is the #1 reason that close corporations, and their owners get penalized by the IRS. From personal experience being brought in to put out these fires, the IRS might be willing to negotiate the size of the penalty, but penalties will be owed, as will back taxes on the tax deemed due, as well as interest on those back taxes. Generally, these close corporation owners will spend more on penalties and interest for a single tax year than they would save in 5 years from this scheme, and that doesn't include legal fees they paid for the audit.

There is no bright-line rule for what a "reasonable" salary is. For low six-figure amounts, the SS contribution threshold is usually considered a safe amount with the rest paid as a dividend, but for seven-figure amounts, different considerations apply. Indeed, at larger amounts, the IRS is actually opposed to close corporations using inflated salaries to reduce corporate income taxes (because salaries are deductible to the corporation but dividends are not).

So: owners would have paid their progressive rate on the XXXk of income received as salary (which is deductible to the corporation), at a likely 22-37% marginal rate, plus up to 12% state income tax rate, for a total of up to 49% including state taxes. The remaining income received as a dividend would be subject to a corporate tax rate of 21%, plus a personal tax rate of 20% (15% on the portion of the dividend income, if any, below the QD 20% rate threshold, which depends on how much of their income they chose to allocate as salary), plus 3.8% NIIT, or a 44.8% rate of federal tax before state taxes on the corporation and the owner are taken into account. Or in other words, usually worse than just taking all of the profits as a salary.

I think this would be difficult to do without tax fraud. You cant retroactively increase your salary to show you were owed more money for unpaid salary.

If they had money in a C-corp to start with, you could run it at a loss (actually paying the salary), and then carry forward those losses to offset the windfall.

With an S-corp, Each year the company ran a loss, they would receive a negative dividend which would adjust their annual earnings down.