Let’s get one thing straight, self-employment taxes suck. The last thing a small business owner needs to worry about is how to pay an extra 7.65% on their net income at the end of the year. But unfortunately, unlike traditional employment situations (where it is customary for the employer to pick up ½ of the employment taxes), no one is coming to pick up the check on an entrepreneur’s portion of the employment taxes. Also, these self-employment taxes are unavoidable and hit the already stretched thin wallets of entrepreneurs everywhere.
How To Pay Yourself With an S-Corp
However, there is one common way to at least reduce the tax burden, and that is to incorporate as a subchapter-S corporation and pay yourself a wage. Incorporating yourself as an S-Corporation allows you to technically employ yourself, within the corporation that you create. This means that the S-Corporation can pay your FICA taxes and then take the full deduction against whatever income you earned in that year. This means that essentially you are in effect, getting the full deduction for whatever wages you earn. However, there is a catch, the IRS will not allow you to pay yourself 100% of your earnings for the year. The IRS states that you must be paid a “reasonable salary”, and that’s pretty much it. If that sounds vague then you’re right, it is. This creates a lot of questions on what a” reasonable salary” is.
So, the question is, how much should I pay myself? Well unfortunately if the IRS doesn’t have any solid answers, then accountants wouldn’t have any solid answers either. Some entrepreneurs have very conservative viewpoints where you would only pay yourself a small salary, and some take ultra-aggressive approaches where they take almost their entire revenue in salary. However, what I would recommend is to ask yourself some questions in order to get to an appropriate salary, and these are.
What is your job?
This seems incredibly redundant but a good question to ask yourself is,” If you hired someone to do your job, what would their title be?”. If you can nail down a specific job title, then it’s much easier to estimate a salary. However, the IRS also states that it must be reasonable for your industry, which brings me to the next question.
What is your industry?
Obviously to estimate a salary, you must figure out what line of work your business is in. For most people is incredibly easy to figure out. For example, if you make steel, you’re in the steel making industry. If you sell flowers, you’re in the flower selling industry. However, for some people, like consultants it’s hard to figure out what specific industry you’re really in. My advice would be to figure out what kind of clients you serve the most. Some examples would be a steel marketing consultant or a flower website design consultant.
How many years of experience do you have?
This is probably the easiest question to answer because it’s not subjective at all. Although your experience doesn’t have to be specifically from your current job it can be from many past jobs that make you more marketable in your field. Generally, the more experience you have, the more you can pay yourself, and the less experience you have in your skill, the less you will be able to pay yourself. Now for the last question.
What does someone with your experience, job title make in your industry?
After you answer all those questions you can now actually come up with an extensive estimate on what to pay yourself. Remember the IRS only says that it has to be “reasonable”, so you do have some lead way on what you estimate but in my opinion, it is better to be conservative than aggressive, but not too conservative. If you take no salary at all then what was the point of incorporating in the first place? Always be sure to check with your accountant and have them help you make the proper estimates, and if you don’t have an accountant and you want to incorporate and save money on FICA, then give me a call at 208-615-5314 or visit WeNeedACPA.com to start your journey to tax savings.