Working out the reasonable compensation levels for your business

When you’re running an owner-managed business, it’s incredibly important to know the right amount to pay yourself.

First and foremost, this is about understanding the remuneration needed to maintain your own personal lifestyle.

But knowing your ‘reasonable compensation’ as the business owner is also critical to minimize tax liabilities and understand how the business is performing.

So, how do you review and find the compensation level that is the best for you, as the owner, and for the business as a whole?

The tax implications of reasonable compensation

If your business is organized as a Subchapter S corporation (S Corporation), the IRS can really wreak havoc if you don’t pay yourself enough.

If your business has 100 or fewer shareholders, you can be taxed under Subchapter S of the Internal Revenue Code, giving you the advantage of having your profits taxed at the shareholder level, rather than the corporate level – so, as the owner, you’re taxed on what you pay yourself, rather than on your corporate profits.

But there is a condition to meet…

The compensation you pay yourself from the business must be seen as ‘reasonable compensation’ and you can’t pay yourself a few dimes just in order to lower your tax bill and save some cash.

So to meet the S Corporation guidelines – and maximize the inherent benefit of the tax break – it’s crucial to have a detailed understanding of the right amount to pay, so you get the best possible outcome from your tax planning.

And, more importantly, it’s also vital to not underpay yourself and create the possibility of your profit being overstated. You don’t want to end up being worse off financially as a business owner than you would have been as an employee, after all.

You can’t manage what you don’t measure. It’s a truth that is hugely relevant when attempting to find that reasonable compensation level and maximize your own income and the longer-term profitability of your business.

So, how do you get a proper handle on your pay and compensation numbers?

In short, the answer is to talk to us. As business advisors to a growing portfolio of owner-managed businesses, we always review your personal finances and business finances in a holistic manner – and that’s the real key to getting your compensation levels correct: to look at the bigger picture and to plan accordingly.

How do we help you find that perfect compensation level? Well, the starting point is to get to know more about you, your business and your core numbers. We’ll ask you to fill out our web-based Reasonable Compensation Survey questionnaire  and that helps us get the answers, numbers and data needed to get a detailed understanding of your accounts, tax position and current remuneration levels.

Finding your ideal compensation figure

The next step is to provide you with a Reasonable Compensation Study report, something we do as standard for all our clients at Holden Moss.

This takes the results of your questionnaire and gives you a full diagnostic of your remuneration levels, the tax you’ll be liable to pay and whether your compensation figure meets the S Corporation guidelines.

Business decisions should never be made in a vacuum: you need context and you the best possible management information to base your decision-making on.

With the right measurements in place, and the results from your Reasonable Compensation Study report, you have the best possible overview of your core profits, tax and remuneration numbers.

And that means you’re primed and ready to find that acceptable level of pay, with a keen eye on the potential outcomes:

  • Set your remuneration too low and the business is set to ‘life support’ status, functioning and surviving but not growing.
  • Set the acceptable level of pay to the right amount and you lower your tax bill, release more profits and have the liquidity in the business to thrive and grow.

Come and talk to us about maximizing your compensation

As you can see, compensation can be a complex area. It’s not just a case of getting your income right, as the business owner; it’s also business critical to understand the tax laws, the IRS guidelines and to find that acceptable level of pay.

If you’d like us to help you find that ideal compensation number, please do get in touch with us.

Contact your local Holden Moss office and let us start helping you to find the right level of remuneration for you and your small business.

Written by

Steve Moss, CPA is a partner at Holden Moss CPAs and loves helping businesses and their owners grow to be the very best they can be. Our other offices include Raleigh, Oxford and Warrenton. We are a little different at Holden Moss CPAs. While we still provide traditional tax and accounting services, years ago we realized many clients wanted help in running their businesses and were hungry for ideas, solutions, strategy, and execution. In response, we expanded our skill set and joined Ran One, a global network of business consulting firms. Our membership with Ran One gives us access to proprietary resources and analytical software to help our clients grow, become more profitable and valuable, and have the lifestyle they desire. Now, blended into the fabric of our normal tax and accounting needs, we are focused on our clients’ businesses in a very different way. While our approach is not right for everyone, for those whom it is, incredible results may be obtained. Whether you have a new, or established, business, or for those in transition of selling or retiring, or for those who simply need to develop an exit strategy or succession plan, our unique approach to client service may be the edge you need.

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