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.