If you own an LLC taxed as an S-Corp the IRS requires that you pay yourself a 'reasonable' salary but they refuse to provide specific guidance beyond that. If you pay yourself too low of a salary (and receive a lot of income via dividends taxed at 15%) then they will demand that you raise your salary (but still refuse exact guidance).
What is the optimal salary that avoids uneccessary audits?
Reasonable is usually defined as the salary someone would make in a similar position at another company. Stated differently, if you hired someone to do your job, what would you need to pay them. In this situation, if you are ever are audited by the IRS, the strongest argument you could make, "the salary I am paying myself is dictated by market conditions, as shown by this competitor _________________."
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If you are *completely* uninvolved in day-to-day company
Alan,
Is the LLC run by someone and is that someone paid a market salary? If the answer is yes, you dividend is net income, which as 100% owner goes to you. This isn't a problem as far as the IRS is concerned.
Alan, take a look at these two free reports here at Proformative - it might save you some grief:
"Top 12 Comp Mistakes: The Bad & The Terrible"
https://www.proformative.com/whitepapers/top-12-comp-mistakes-bad-terrible
"8 Ways You Could Be Increasing Your Company’s Audit Risk:"
https://www.proformative.com/whitepapers/8-ways-you-could-be-increasing-your-company-s-audit-risk
I hope it helps!
Best... Sarah
That is correct advice
Agreed, furthermore, this issue is of particular importance because the IRS tends to audit S Corporations/Owners because a lower than reasonable compensation level provides payroll
Alan, are you trying to say that your 100% ownership represents passive income? The IRS will be looking at what other earned income you have to sustain yourself. If it appears that most of your living wages are generated by the LLC, then there will be an expectation from the IRS that you earned a salary.
Sometimes, it is better to bite the bullet and pay the higher salary taxes than to raise a red flag and have to then defend your position under IRS scrutiny. Once the IRS finds a reason to audit you due to the red flag of salary, rest assured, they will look at other areas on your tax return as well.
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I disagree. It can be a passive investment and in that case you need not be paid a salary if you are not involved in operations. For instance, you may be retired but still own the company and you've hired a manager or CEO to take over the business operations. That being said you will need to prove you are not involved, and that also makes losses passive. Additionally starting 2013 the 3.8% medicare tax will apply to passive income generated from S Corporations.
Hi Alan,
To focus on the practical question of how to come up with a number, you could research both job postings and public industry salary surveys in your field for "comparable" type and level of work that you perform and develop a range. As in other "arm's length" valuation exercises, it is typically safer to pick a number that's within the interquartile range -- naturally you can lean to the lower quartile depending on your audit
Jake
My Firm works with many entrepreneurial companies and the tax acccountants are always talking about this particular topic. The advice I give is to pay yourself a salary and bonus commensurate with other companies in the same vertical industry with approximately the revenue same sizes.
Any salary and bonus paid out in excess of this guidance is penalizing yourself, your
If the law was black and white, then the guidance would be different but it is not.
We have an LLC and are currently investing all cost, including the salary of our single employee. My question is, do I still have to declare myself an employee? We are not having any profits at the moment and might not show a real profit this year.
