Reasonable Compensation for S-Corporation Shareholders
December 31, 2018
With the new tax cut and jobs act, 20% of net income from a pass-though entity will be deducted from your income. Therefore, scrutiny of a reasonable compensation will increase by the IRS. In this video we will discuss how to establish a reasonable salary for owners, so you can avoid any potential IRS problems.
Income from a S-corporation is not subject to self employment tax. This is why a S-corporation is an attractive way to operate a business. Business Owners of a S-corporation or Shareholders take money out of their business in two ways. First through payroll, which is subject to FICA tax (15.3% up to $132,900 in 2019) and secondly through distributions or dividends without paying payroll tax.
Shareholder’s compensation is a must for a profitable S-corporation, where the owner is actively involved in the business and takes money from the business on a regular business. However, determining how much compensation is reasonable is another question.
The factors that determine the amount of a reasonable compensation can be :
Fair Market Value of the compensation if the owner worked somewhere else.
How much the company is making.
How much does the owner need to cover their living expenses and whether or not he or she has a working spouse to cover a portion of the living expenses.
I would recommend to pay yourself at least 40% of your business net income as a shareholders salary and subject that to all necessary payroll taxes and take 60% as distributions.
Also keep in mind that only W-2 income determines your future social security. Therefore, I strongly suggest to create a business retirement plan, such as 401K, Solo 401K, Simple IRA or SEP and contribute to your future retirement fund as well as deduct these contributions as your business expense.
Also, make sure you properly record shareholders compensation on line 7 of your tax return form 1120S ( officers compensation). Only your employees salaries are recorded on line 8 - salaries and wages. If you have subcontractors and issue them 1099 forms, these expenses are reported under cost of labor or other expenses depending on the nature of the subcontractors and the amounts paid.
If you have any questions and want to work with a knowledgeable and proactive team by your side please contact our company, Colorado Business CPA, LLC.
In one monthly fee we provide full tax, accounting and payroll services plus business coaching!