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I am the only owner/officer/employee of my s-corp. From time to time I perform programming service for my only client on hourly basis during evening/weekend hours through my s-corp (aside from my daytime job). My s-corp gross receipts are about 10% of my daytime job salary. Since IRS requires me to pay reasonable wages to myself, I decided to calculate my wages based on the same hourly rate as I get on my daytime (full-time) job and take leftovers of s-corp profit as distribution. Relationship with my client is quite special, so my corp-corp rate happens to be twice higher than hourly rate used for my wages, so total amount of my distributions is almost equal to total amount of my wages, but my client does not pay any regular fees for software usage. I believe that I won't be able to get same corp-corp rate with any other client in my area with fresh start (and I definitely would if I could). I pay wages monthly depending on number of hours worked, I pay distribution once per year in December. Will my determination of my "reasonable wages" be satisfactory to the IRS ? If not, how much should I pay myself as wages to feel safe ? |
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This is a hot issue for the IRS today. The amount of salary you pay yourself is factor of many items. Certainly comparable salaries for for comparable work is the best indicator but may not be available. Your role may cross several lines. Besides work for clients you do administrative work for the corporation. You may also do marketing. All these factors need to be taken into account. In addition, you are entitled to a reasonable return (distribution) on your investment in the corporation. Is it capital intensive? If so this would indicate a larger distribution than a service oriented business. At the end of the day, I would keep a log of all of your activitites on behalf of the corporation and pay a reasonable wage based on the total of these activities. Wonderful answer Howard!
(28 Jun '10, 15:32)
SandySea
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The Senate has passed a bill that is in the House, which our President has promised to sign that would subject S Corp pass through income to Self Employment Tax providing that the income from the S Corp is generated by 3 or fewer professionals. What you do may be considered professional consulting and your industry may be covered by the rule WHEN it passes. I emphasis when because it seems likely that it will pass. Generally, prior to this proposed change, I usually use sites like Salary.Com to get a starting point for reasonable compensation. Your methodology is also basically sound. The code does not quantify what reasonable is so as long as your methodology is gounded you should be fine - for the time being. THANK you for salary.com search
(30 Jun '10, 21:41)
SandySea
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Reasonable salary is just that. Reasonable for what someone else would do the work for in the same capacity. You can essentially pay a reasonable salary based on what is going rate in this recession for the same work. Whether you pay it to yourself or another is a moot issue. To take however the REST of the money as distributions may be viewed as trying to usurp the self employment taxes. Your S-corp should be operated for profit which means increased basis on the business. Make sure you are not using the bank account as your personal piggy bank account to keep from blowing your S election :) |
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If you want to be truly safe, pay yourself up to the SS limit, then distribute the remaining. He already has a job so is paying into SS. Reasonable salary as Boise stated can show you comps for your area of what the same type of work is done for what prices...high/low. S corps are often used as opposed to SMLLC's to save on the SS taxes, so I would not think this is something that should be considered. Reasonable yes, to keep it "safe"...nada. JMHO
(28 Jun '10, 15:27)
SandySea
I've heard this promoted by other sources too. I don't know that that's "truly" safe, but at least you're in better shape than someone who is paying themselves 10K as salary and 90K as distributions. However if you're earning 300 or 400K (or more) and paying out only the SS limit as salary, you'll definitely still attract the attention of the IRS. (See, for example, Menard, Inc. v Commissioner, 103 AFTR 2d 2009-1280. In this, the taxpayer did win on appeal, but it's an instructive case.)
(28 Jun '10, 16:57)
Tom
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Your state department of labor should produce statistical data relating to high/low/average/median wage for different job titles. You can start there to find if your "reasonable" wage falls somewhere around those figures. Since you know what wage you receive as an employee elsewhere, that is also a good indicator of reasonableness. But beware the trap of having too much remaining as non-wage net income, as distributions - this could cause problems down the road. Thinking like an auditor: but if you're earning substantially more than the average, presumably there's a reason. If it's because you're better than average, then is it reasonable to only be paid an average rate?
(28 Jun '10, 17:00)
Tom
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Reason could be for expansion; hiring new employees, or any other reason. If distributions are high however, then it is a piggy bank and will be questioned I am sure. I still would say to my S corp clients to pay a reasonable salary for the PRIMARY work they do and do not take distributions that are unreasonable...keep in mind the 60/40 at that point. But first and foremost, pay yourself a salary in the mid range and leave profits in the S corp for future benefits of the corporation. Good question Tom!
(29 Jun '10, 17:13)
SandySea
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I think your basis is solid since you are saying "reasonable" is the market rate for your services, which is your hourly W-2 income (although the IRS may add to this whatever benefits you receive from your employer). The problem is that there are no definitions or rules as to what is "reasonable", so the taxpayer is on the hook to prove "reasonableness",as you are doing. 1
And as for the basis for your "reasonableness": document, document, document! Keep records of websites with wage info, how you calculated your salary, etc.
(08 Jul '10, 18:50)
cpaboise
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