What is a Reasonable Salary_

What is a Reasonable Salary?

If you have been following our series of posts about S-Corps, then you may be familiar with the phrase “reasonable salary.”

But what is a reasonable salary?

The IRS is particular about paying yourself a reasonable salary since your salary is subject to payroll taxes. There are a variety of ways to calculate your reasonable salary, and the IRS tends to work with a nine-factor test.

The factors are:

(1) Employee qualifications;

(2) The nature, extent, and scope of the employee’s work;

(3) The size and complexity of the business;

(4) Prevailing general economic conditions;

(5) The employee’s compensation as a percentage of gross and net income;

(6) The employee-shareholder’s compensation compared with distributions to shareholders;

(7) The employee-shareholder’s compensation compared with that to non-shareholder employees or paid in prior years;

(8) Prevailing rates of compensation for comparable positions in comparable concerns; and

(9) Comparison of compensation paid to a particular shareholder-employee in previous years where the corporation has a limited number of officers.

 

When we help clients with the above, we tend to ask a lot of questions and then document the process we follow. Documentation is key: if the IRS ever audits or reclassifies your distributions as salary, you need to have data to backup your numbers.

Based on the above factors, we discuss what your education and licensing level is, how your practice is set up, how your firm is doing, and the state of your financial data. Someone grossing $250,000 in their firm is going to be paid differently than someone grossing $75,000.

This, of course, goes back to the point that you need to be making enough money to make it worth electing to be an S-Corp.

Many private practice therapists who we’ve worked with have salaries ranging from $45,000 to $130,000, for example. Determining a reasonable salary depends on what is going on in your business and the factors involved in your business. A reasonable salary is not going to be the same across the board since every practice is different.

TL;DR: We recommend that you document how you determined your salary. Reach out to us if you need some help deciding what reasonable compensation looks like for you.
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How do I hire Someone?

First…take a step back. While you might have someone already picked out for an open position in your practice, you need some lead time before you can hire someone in Washington State.

Do you already have a payroll system set up? If you’re an S-Corp, you should. If payroll is already established, the hiring process can often be a little quicker.

If not, then you will need to file a NEW business license application. When you apply, the purpose will be “hire employees.”

We recommend that you file for a new business license online since it is the quickest way to apply.

Now the wait begins. This is why I mentioned that there will be some wait time. You will need confirmation letters for workers’ compensation and unemployment insurance from the Department of Labor and Industries and the Employment Security Department.

Once you get the confirmation letters, you will need to setup your payroll. We recommend using Gusto (our affiliate link) for payroll. We can either help you set this up or you can purchase Gusto (or use another method) on your own. We do not recommend QBO Payroll, we have seen to many mistakes happen.

From here, you’ll need to get your new employee set up and on payroll. You will also need to make sure that you are following the various Minimum Wage Requirements and Labor Standards Act.

If you are an S-Corporation with a retirement plan, hiring employees can be a little more difficult  if you have a retirement plan in place for yourself. We will discuss some of these topics in future blog posts.

TL;DR: Make sure you are set up for payroll before you hire someone. We recommend discussing this with a professional as messing payroll up is very easy. As always, we can help!

How much should I pay myself_

How much should I pay myself?

It depends.

No, really — it does.

I ask each client a handful of questions when trying to determine how much they should compensate themselves:

  • What industry are you in?
  • How much work do you do?
  • Do you have any employees?
  • How much money are you currently making?
  • Are you a PLLC or LLC?
  • Are you an S-Corp? (The below information does not apply to S-Corps because S-Corps require a reasonable compensation.)

Generally, I’ll look into your records and cash flow to help determine your salary.  However, the following chart works well as a general outline to determine your compensation, especially for service-based businesses like a Therapy Practice, Massage Therapist, or Chiropractor.

Income Between Recommended Compensation
$0 to > $250,000 50%
$250,000 to $500,000 35%
$500,000 & Up We should talk

 

What if I can’t afford to pay myself in those ranges?

It might be time to dig into your expenses and see what you are spending money on. When looking at your expenses, ask yourself: is this required or does this bring in clients?

If the answer is no, should you really be spending money on it?

TL;DR: Figuring out what you should pay yourself is difficult. To determine your salary and compensation, speak with a professional for advice.