My previous post posited that it isn't what you make but what you keep. The every day wage earner who gets taxes withheld from each and every paycheck knows this is true. The wage earner is often hourly and has incomes tax both fed and state withheld along with the employee share of Social Security and Medicare taxes.
Only about 6% of earners hit the Social Security Maximum wages of $160K+/-. Here is where that stat comes from https://www.ssa.gov/policy/docs/population-profiles/tax-max-earners.html.
So 94% of the wage earners in the US pay into Social Security and Medicare on ALL of their wages. Some day when their is no alternative, Congress will eliminate the cap entirely. The day will come sooner rather than later.
Under current law, S Corp owners are exempt from paying SE tax (the 15.3% equivalent of SS and Medicare for both employer and employee share). There are 5MM S Corps. The IRS requires that S Corp owners take a reasonable salary which is not set in stone as to an amount. Different theories exist on what is “reasonable” and this subject is no doubt one that will be audited more and more as those new 87,000 IRS agents come on line. In spite of this potential audit risk, I still recommend S Corp structure for tax savings. A typical set up would bring in 100K, pay a $30K salary to the owner and after expenses pay flow through profits of whatever amount is made in the year. Is that $30K reasonable. That depends, but be assured that there are many ways to skin this cat. Reasonable could be that specific industries norm, or what you'd pay another non-owner to do the same job or some other pay scheme that gears it to performance etc. The IRS can't tell you what is reasonable but they CAN tell you to prove your choice as to what is reasonable. This of course, becomes arbitrary. The new Biden army of agents will find a lot of S Corp owners caught off guard and no doubt declare many salaries as not reasonable. Sure, you can fight it but at what cost. The IRS realizes fully that most small businesses will not fight and therefor this is taking candy from a child. Just another day at the IRS.
To be better prepared, develop a few different ways to look at “reasonable” and have the aggregate in mind when deciding on a salary. Since this is so gray, many accountants will advise to start low but still have reasoned it out. If challenged, any change forced upon you will likely be going forward
I was hit on this very item back in 1994. A negotiated settlement was reached and I was still ahead of the game. I knew about this as a potential audit risk and took that chance. In my case, it worked out. Use good judgment and do what you believe is supportable. I can't do more here than bring this to your awareness because it will be a big audit issue with 5MM S Corps out there.
Very Reasonably Yours,
Donn Marier
DM-Your Own CFO