If you are self-employed and operate under the corporate structure (c or s corporation), you have probably asked yourself what is a reasonable wage to take out of my business. Not only do you have to take wages out to meet your personal needs, the IRS also requires you pay reasonable wages.
The IRS requires paying reasonable wages because of the multiple ways corporations can take money out of their business. Paying wages to yourself is the least tax advantageous way to withdraw money from your business, as a result business owners with corporate structures will rather use other methods. For instance taking money out as distributions triggers less tax than taking money out as wages. The IRS is aware of this conflict and fights hard to ensure corporate owners do not avert taxes by refusing to pay reasonable wages.
IRS considerations in determining reasonable wages
-
Training and experience
What type of training and experience do you have? For example a graphic designer with a master’s degree and 10 years of experience should be paid more than one who just read a book about graphics design before starting his/her business.
-
Comparable Business
How much will a comparable business pay you for your skills? A comparable business is one with relatively the same size as yours. Size could be defined in terms of revenue, net profit or number of employees. If a comparable business will pay someone else $40,000 to do the same work, then it will be reasonable for you to pay yourself $40,000.
-
Location
The average pay in your area for the type of work you do should also be taken into consideration
-
Duties and responsibilities
How much time do you spend working in the business? Obviously, the more you do the more you should pay yourself
-
Payments to your employees
Your employees who do less work should not earn more than you do.
-
Using a formula
If you use a formula to determine pay is also taken into consideration. For instance you can decide to pay yourself 30% of profits after certain expenses are deducted
-
Research tools
The IRS will also consider research tools as reasonable means of determining compensation. You can find a lot of salary comparison surveys online by doing a simple google search.
I like to recommend how much you pay yourself be part of an overall wealth building plan. A detailed analysis of all your financial situations should be taken into consideration in determining what your pay should be. Talking to a CPA who understand these issues will be beneficial to you.