One of the key decisions you’ll need to make as an S Corporation (S Corp) owner is how much to pay yourself. This decision involves balancing your salary and distributions to maximize your tax benefits while complying with IRS regulations. In this blog, we’ll explain how to determine a reasonable salary, balance salary and distributions, and practical strategies to manage your S Corp effectively.
What is an S Corp?
An S Corp is a special tax designation that allows a business to pass its income, losses, deductions, and credits directly to its shareholders, avoiding double taxation. Unlike a C Corporation, an S Corp’s profits are taxed only at the shareholder level, not at the corporate level.
Paying Yourself as an S Corp Owner
One of the fundamental rules for S Corps is that owners must pay themselves a reasonable salary. The IRS requires that you pay yourself a salary comparable to what you would pay someone else to do the same job with the same qualifications. This salary is subject to payroll taxes, which include Social Security and Medicare.
What is a Reasonable Salary?
A reasonable salary reflects the market rate for your work for your S Corp. It should be based on industry standards and adjusted for your level of experience and the location of your business. Paying yourself a reasonable salary is crucial because the IRS scrutinizes S Corp salaries to ensure compliance with tax laws.
Balancing Salary and Distributions
As an S Corp owner, you can take additional income from the business through distributions. Unlike salaries, distributions are not subject to payroll taxes, which can result in significant tax savings. However, you will still owe income tax on any distributions you take at the end of the year.
Common Approaches to Salary and Distributions
There is no one-size-fits-all approach to splitting salary and distributions, but common approaches include a 50/50 or 60/40 split. You might take 50-60% of your income as a salary and the remaining 40-50% as distributions. The ideal split can vary depending on your industry, role, and business performance.
Key Takeaway
The key takeaway is to ensure that your salary is based on industry standards and adjusted for your experience level. This approach helps demonstrate to the IRS that you must pay yourself a reasonable salary.
Practical Strategies for Managing Your S Corp
Here are some practical strategies to help you manage your S Corp effectively:
- Pay Yourself a Salary Based on Industry Standards
Research industry standards to determine a reasonable salary for your role. You can use resources like the Bureau of Labor Statistics, industry reports, or compensation surveys. Adjust the salary based on your experience, skills, and business location.
- Balance Your Salary and Distributions to Maximize Tax Savings
Work with a knowledgeable accountant to find the optimal balance between salary and distributions. This balance can help you maximize your tax savings while ensuring compliance with IRS regulations.
- Regularly Review and Adjust Your Salary
Your salary should be reviewed and adjusted regularly as your business grows and evolves. This ensures that it remains reasonable and reflective of your contributions to the industry.
- Keep Documentation Justifying Your Salary Decision
Maintain thorough documentation that justifies your salary decision. This can include industry salary surveys, compensation studies, and records of your business’s financial performance. If the IRS ever questions, proper documentation can help you defend your salary.
- Consult with an Accountant
Consulting with a knowledgeable accountant is essential. They can provide valuable insights and help you navigate the complexities of S Corp taxation. An accountant can also assist you in determining a reasonable salary and balancing your salary and distributions effectively.
Using RC Reports for Salary Determination
RC Reports is a company that can help you determine what a reasonable salary is for your role. They charge $449 for a reasonable compensation report, which includes a questionnaire and consultation. This service can provide an accurate and defensible salary figure, helping you comply with IRS requirements.
Key Features of RC Reports
Reasonable Compensation Report
- RC Reports provides a comprehensive report that helps you determine a reasonable salary for your role as an S Corp owner. This report includes an analysis based on industry standards and your specific job responsibilities.
Questionnaire and Consultation
- When you purchase an RC Report, you will complete a detailed questionnaire about your role, experience, and business. The report also includes a consultation with an expert to ensure that your salary determination is accurate and defensible.
Detailed Analysis
- The report offers a thorough breakdown of how the reasonable compensation figure was calculated, clearly understanding the factors considered.
Compliance Assurance
- Using RC Reports helps ensure that your salary decisions comply with IRS requirements, reducing the risk of reclassification and penalties.
Pros of RC Reports
Accurate Salary Determination
- RC Reports uses industry data and professional analysis to provide an accurate and justifiable salary figure.
Expert Consultation
- Consulting with an expert adds an extra layer of assurance and personalized advice.
Compliance and Risk Reduction
- By providing a defensible salary figure, RC Reports helps you stay compliant with IRS regulations, reducing the risk of penalties and reclassification of distributions.
Cons of RC Reports
Additional Cost
- While the service is cost-effective, it is an additional expense that some small business owners might need help with.
Not a Substitute for Ongoing Accounting Advice
- RC Reports is a valuable tool, but it does not replace the need for regular consultation with an accountant or tax advisor.
Conclusion
Paying yourself as an S Corp owner involves finding the right balance between salary and distributions. This balance can help you maximize your tax savings while ensuring compliance with IRS regulations. By paying yourself a reasonable salary based on industry standards, balancing salary and distributions, regularly reviewing and adjusting your salary, keeping documentation, and consulting with an accountant, you can effectively manage your S Corp and take full advantage of its tax benefits.
Remember, while this blog provides general guidelines, it’s crucial to consult with a professional accountant or tax advisor to determine the best approach for your specific situation. Doing so ensures that your S Corp operates smoothly and remains compliant with all tax laws.
