s-corp- what % do you consider your wages?

[huggytree]

im a LLC and i file as an S-Corp.

You are double social security/medicare taxes only on your wage
you pay no ss/medi on your company profit

the trick is it says you have to pay yourself a 'fair wage'

im questioning my accountants idea of a fair wage....i consider it what a journeyman plumber makes...$33 per hour = $66,000 a year......

he has my wage at 55% of the total profit which is more than the $66,000

if someday i have 10 employees and make $500,000 per year he would have my fair wage at $275,000....i probably need to consult with another accountant to find out what is normal

[Evan]

A reasonable salary would be what you'd make if you were to hire a person to do the same job yourself. So if you were to hire someone to work with you, how much would you pay them per hour? Do the math on it, and that is your magic number. If you're unsure of the average salary based on your industry, you can always do a search for it. You may wish to print this out and keep it, as it is your best evidence in your favor.

Some accountants like to use "rules" such as 50% salary to 50% distributions, or other variations (60/40, 40/60, etc., etc.). That isn't always the case. Granted your return may receive more scrutiny if you pay $60,000 in wages, but take out $120,000 in a distribution, there isn't necessarily anything wrong. Especially if you have evidence that the $60,000 is what the "average plumber" makes.

I believe your accountant is trying to be conservative to prevent an audit. If he is a CPA, EA, or attorney, he could represent you before the IRS (if needed) should this be something that goes to the Tax Court. The cost for such representation can vary, but in any case, it'd definitely diminish any "savings" in tax if you actually need to fight this.

The IRS generally wants distributions to be reclassified as a salary so they can collect employment taxes (15.3%), plus penalties (for late payment) and interest (drats!).

Keep in mind that the salary has to be "reasonable". It doesn't need to be "average", and sometimes that number can be different. All in all, it depends on whether you want to defend your choice.

Your accountant is just trying to looking out for you. If you believe a reasonable wage is less, tell him you wish to use that amount. I'm sure you should be able to reason with him on the issue.

[kenlew]

You might try one of the salary sites that give estimates for your geographical area. Just print the results and put it in the file.

[Steve B]

Using a percentage is just plain wrong. It's impossible to say that 50% of your profits (or any percent) is a "reasonable" wage since nobody in the plumbing world gets paid that way (except for other owners). Use the "reasonable" amount that you came up with - it sure sounds reasonable to me.

Don't forget that a journeyman is only getting paid for hours worked - and you've said you don't work a lot of hours in some months - so, is it really $66,000 that you should be using during years where you're not busy full-time?

[Evan]

In the accounting world, we tend to use the 90/10 rule: 90% of problems come from 10% of your clients.

And Steve, the problem isn't so much the percentages as it is the "reasonableness" of the salary. While you may be correct, do you really want to pay to have your case represented in Tax Court because you believe your salary is reasonable and the IRS doesn't?

[Business Attorney]

I think Evan's discussion is excellent. I just want to comment, Dave, on your statement that "if someday i have 10 employees and make $500,000 per year he would have my fair wage at $275,000 ..."

Perhaps today you can justify paying yourself what a journeyman plumber makes (although it sounds like you are more of a master plumber from your posts). When you have 10 employees and are making $500,000, you are probably going to find it hard to argue that you are just a simple plumber. At that point, you will clearly have both supervisory duties and executive responsibilities that take up a significant amount of your time. Your "reasonable" compensation will have to reflect those duties and responsibilities. That still may not be $275,000, but it is certainly going to be much higher than what you can justify based on a comparison to a journeyman plumber's hourly wage.

[Steve B]

I think it certainly makes sense to adjust your reasonable wage from year to year as your business grows. Good points about recognizing the supervising aspect as the business grows.

Basing it on a percentage of the profit however makes zero sense. The IRS is wanting you to represent a reasonable wage and this should be something you can defend (with relevant comparisons). The $66,000 may end up being the best answer, but NOT because it's 55% of the profits. I would certainly be comfortable using something that reflects the limited hours he has worked during the slow months - so, perhaps it would end up at less than $66,000 (and I wouldn't mind going to tax court if it were questioned).

[huggytree]

the next time i meet an accountant im going to ask him about this whole thing...maybe ill setup an appointment with one just to find out if mine is scr**ing me.....he gave me 1/2 the info needed for my IRA decision this year...he said to go with a SEP IRA, when a Roth would have been better....yea i save some tax $, but nothing can beat a Roth in the end...

I am a Master Plumber, but that position doesnt may any extra...journeyman wage is it.

including office time id say i work 2,000 hours a year....1,100 in the field last year

[huggytree]

had a long discussion with my accountant today...he has me at 55% for my wages, but says the more i make the lower that % will go.

i still think he has me way over where i belong, but what do i know?...every $1 he has me over = 15% extra tax i pay (s.s. and medicare)....so its a major deal to me....i could shop around accountants to find one who lowers me down, but atleast i know if audited im safe with this guy....I have a plumber friend who made almost as much as me last year, so i can see where his accountant put him at...he's more cautious than me, so it should be a good comparison

[Evan]

A Roth IRA may not be beneficial, especially with things the way they've been. If you invested $10,000 and it lost $4,000 -- you cannot write off that $6,000 loss and the $10,000 wasn't excluded from income (and taxes) like you can with a traditional IRA.

The Roth IRA also assumes that you'll be in a higher tax bracket when you retire. That may not also be the case.

And, of course there is also the possibility that Congress could phase out the income tax and instead have a "consumption tax" (like a national sales tax). In that case, there would be no benefit of a Roth IRA at all.

[huggytree]

i found out that a roth has a max income limit...im very close to that for 08 year and in 09 i plan on being over that amount...so a SEP will be my only option..

if im under the limit for 08 i may throw in the max before april for 09's retirement.....basically pay for last year's ROTH with this years money.

[Baseline]

Huggy-

I'm a small Land Surveying company, 15 years, and between 1-8 employee's, depending on workload. My salary is around 50%- even in the years when I have more employee's. You will never, ever, ever be as efficient as when you work solo; and each employee will drop your profitability. You'll need more admin, more insurance, more materials, supplies....... and we're not even touching the mistakes THEY will make that you have to pay for. Trust me- to extrapolate that 5x more billing makes 5x more profit is- in my experience- wrong. You'll make more; but how much more will depend on a lot of factors that are not in your control. And if you gear up, and buy Trucks, and outfit them, and have insurances......... and the economy goes way south....... you still have to make those payments. Business will go up and down; sheltering isn't always the "best" way to go, if your business can be cyclical. IMO, of course....