Don't be blindsided by an audit: S Corp Reasonable Compensation - How much should I pay myself?

It's tax season. In fact, taxes are due next week (18 April)! Don't be blindsided by an audit. If you're an S Corp and you make a profit, you need to pay yourself. How much should you pay yourself? The IRS requires you to pay yourself a 'reasonable compensation.' Why is this important?

S Corps are one of the most heavily audited business tax entities.

Here's why: 

  1. There are just a LOT of S Corps. In 2002 there were over 3 million registered S Corps.
  2. S Corps aren't just mom and pop companies. S Corps with $10 million + assets is the fastest sub-group of S Corps. S Corps are the most popular business tax designation.
  3. They are a favorite amongst small businesses who often lack the resources to hire professional legal and accounting services and we tend to think that since we're the little fish, the IRS isn't going to waste their time chasing down a minnow when there are whales to be caught. We think we can fly under the radar. 
  4. There is a lot of flexibility in compensation: wages, dividends or a combination. Flexibility leads to confusion and inappropriate distribution of profits.
  5. The IRS estimates that each year there is a gap in gross reported figures of...wait for it...$300 billion! There is a problem - a $300 billion problem.
  6. The IRS believes that the bulk of this gap is from small businesses.

 The bottom line: it's all about the $$. 

One of the easiest ways to avoid a problematic audit: pay yourself a 'reasonable compensation.' How much is enough? Here's how to figure it out:

  • Don't just guess. If the IRS audits you, having research and hard #s to justify your compensation is key. 

  • Research: If you're still thinking about yourself as a crafter, this is where that ends. You are officially a small business owner, manager, social media marketer, administrator, strategist, etc. Use career sites (Monster, Career Builder, Linked In), national statistics (BLS.gov and payscale.com), and industry trade groups. 
  • Pay the min: In 2015 and 2016 the Social Security Administration set the 'base wage' to $118,500. This rate allows you to pay (and the government to collect) all the payroll taxes due. And when the government gets their cut, they're much more likely to leave you alone.