Compensation is a subject that never goes out of style. For owners of subchapter S corporations, the focus is typically on the definition of “reasonable” compensation. Since no specific authoritative guidelines exist, the determination comes down to facts and circumstances.
With potential penalties and payroll tax assessments at stake, setting your salary at a reasonable level can keep tax disputes at bay. Here are suggestions for a year-end review of your compensation.
- Create a written employment contract. You may be the only employee in your business. But the process of writing down your responsibilities can highlight congruencies between the services you provide and the salary you take. Incorporating the advice of outside mentors lends credence to compensation decisions.
- Investigate market data. Look for salary surveys from businesses in your industry or profession. Comparability data is not always easy to come by, but benchmarking against your competitors provides support for specific salary levels.
Online databases that list salaries and responsibilities for a variety of jobs are available, and some of these “career communities” offer free resources. Generally, these sources are more persuasive than simply setting your salary using a “rule of thumb” method based on financial statement ratios.
Determining a reasonable salary is a task you’ll want to tackle sooner rather than later. Whatever method you choose, be sure to document your decision-making process.