One of the challenges of setting a reasonable compensation amount for shareholder-employees of an S corporation is that no official “safe harbor” exists.
Well, none exists other than simply calling all your business profit “wages”…
But that doesn’t stop people—especially business owners who find themselves making a lot of money in their S corporations—from wanting to have a safe harbor.
In this short post, then, I want to provide a handful of salary levels you can maybe think about as “safe harbors”…
The Buffet Rule
Warren Buffett is famous for many reasons—not the least of which is lending his name to a suggestion that the super-rich should pay a minimum amount of tax.
If you’re an S corporation shareholder-employee, however, it would appear that you can also look at some of Mr. Buffet’s recent year salary amounts for a rule people seem to think is an okay salary for an entrepreneur.
As reported by CBS, in 2010 Mr Buffet says he paid $15,300 in payroll taxes. Because the combined payroll tax rate is 15.3%, that $15,300 of payroll taxes suggests Buffet earned $100,000 in wages… and that suggests a $100,000 salary level might be very reasonable for your own small business owner salary.
By the way, I acknowledge that inflation should have pushed up wage levels since 2010, the year in which apparently Mr. Buffet paid this payroll tax burden… but, er, he’s also running a giant global conglomerate—and you (and I) aren’t…
The FICA Maximum
Another unofficial safe harbor you may want to consider? The FICA limit, which is $118,500 in 2016.
Some and maybe even most tax people think that setting your salary level to the FICA maximum works as a safe harbor because it allows the IRS to collect the maximum amount of Social Security taxes from employee and employer.
As reported in my ebook on setting S corporation salaries, I’ve heard an Internal Revenue Service S corporation expert state in a large public tax practitioner forum that the FICA limit provides enough shareholder-employee compensation to be almost automatically considered “reasonable.”
Note: If you make so much money in your S corporation that using the FICA limit sounds too low, keep in mind that in addition to a $118,500 salary, you would presumably also have additional tax-free fringe benefits that further increase your compensation and figure into its reasonableness. Health insurance and an employer pension might add thousands of dollars of compensation, for example.
The 401(k) Plan Optima
I have one final idea you might want to think about as a safe harbor salary amount for your S corporation.
What you might decide to do in a situation where you’re running a one-person S corporation is set the salary level to the level that lets you maximize your 401(k) contribution.
This requires you to do a bit of math, but in 2016, for example, you can contribute up to $18,000 to a 401(k) plan if you’re younger than age 50 and up to $24,000 if you’re age 50 or older.
Further, the employer part of the pension can equal 25% of your wages though the total amount that goes into your 401(k) can’t be more than $53,000 if you’re younger than age 50 and more than $59,000 if you’re age 50 or older.
Work through the math, though, and you can compute that this all means you might set your wage to $140,000.
At $140,000 of wages, you could do a 25% of $140,000 employer contribution (that would be $35,000 of employer match pension fund contribution).
And then if you are younger than age 50, you could add the $18,000 of elective deferral—the employee part—to get all the way to $53,000.
Or if you’re 50 or older, you could add the $24,000 of elective deferral to the $35,000 and get all the way to $59,000.
Further—and this is maybe an obvious comment—if you have a base salary of $140,000 and you also get a $35,000 pension contribution from your employer, that $175,000 of combined wages and pension match gives you a pretty dang high salary and one that should survive most challenges of “unreasonable compensation.”
Note: Okay, we’re’ talking safe harbors here, but I am compelled to point out that bumping your salary so you can bump your pension contribution probably doesn’t save you taxes. Yes, it maximizes your pension deduction. Absolutely. But most likely it doesn’t once you consider all the costs save you money. (You can check out this post if you want the gritty details of my argument.)
Two Downloadable eBooks You Might Find Interesting
Because we’re on the subject of S corporation shareholder payroll, let me mention something. People regularly email or call and ask about how to set a reasonable yet low S corporation salary and how to do payroll for a single employee situation easily and cheaply.
Accordingly, we’ve published a couple of economical ebooks: our $10 Five Minute Payroll ebook and our $37.95 Setting Low Salaries for S Corporations ebook. So let me give you the lowdown.
Completely updated for 2016, the Five Minute Payroll ebook explains how to do simple cookie-cutter payroll for most one-employee S Corporations using base salary amounts of $10,000 a quarter or $16,000 a quarter. (These amounts mean annual compensation levels of $40,000 or $64,000 for a shareholder employee and this may work, especially if combined with a pension or health benefits, for almost everyone.)
The Five Minute Payroll e-book includes sample IRS forms you can copy to get your quarter end or year end payroll done in a few minutes, including 941s, W-2/W-3 and 940. Furthermore, the e-book provides some common-sensed tips you can use to set a reasonable salary for your S corporation and to minimize your state payroll taxes burden, too.
If you’re interested in buying and then downloading this $10 ebook–which should mean you don’t need to use a third-party payroll service– click this button:
Written in plain, everyday language, our Setting Low Salaries of S Corporations ebook explains how to save thousands of dollars a year with your S corporation–but at the same time how you can do so ethically and responsibly and in a way that minimizes both the chance that your S corporation tax return will be examined and the chance your S corporation salary will be rejected by the Internal Revenue Service.
Priced at $37.95, this ebook should save you thousands of dollars a year in payroll taxes. To buy and download the S corporation salaries ebook, click this button:
Accordingly, if you want help with this tax decision, you may also want to get and carefully read my short, easy-to-understand ebook, Setting Low Salaries for S Corporations. But do note: If you’re a CPA firm client, you don’t need to purchase this ebook. Just email us and ask for your complimentary copy.
A final comment. All of our monographs and ebooks come with a money back guarantee. If you don’t think what we deliver is worth the price you’ve paid, just let us know and we’ll refund your purchase price. (Refunding your purchase price, by the way, often takes a work day or two because the funds get handled manually when we’re in the office.)