How Small Business Owners Can Pay Themselves Properly

As a small business owner, finding the right balance between passion, profitability, and paperwork can be a challenging task. One of the most puzzling aspects is determining how much to pay yourself. It's crucial to avoid guesswork here, as your salary can impact everything from tax compliance to the future stability of your business. This post will guide you through the significance of figuring out a fair salary and avoiding costly IRS pitfalls.

Understanding Reasonable Compensation Analysis

A reasonable compensation analysis involves a structured approach to determine an IRS-compliant salary. This means considering various factors such as your role, time spent, industry salary benchmarks, and regional data to arrive at a fair compensation amount.

IRS Criteria for Salary Evaluation

The IRS evaluates reasonable compensation using several factors, including your background, job duties, business profitability, wages of comparable employees, and historical pay structures.

Risks of Undervaluing Your Salary

Paying yourself too little can have serious consequences, such as reclassified distributions, back taxes, penalties for employment tax mistakes, and even a potential loss of S corporation status.

Beware of Simplistic Rules

Some business owners attempt to minimize taxes by adhering to rules like the '60/40 rule', which involve taking small salaries and large distributions. However, the IRS does not accept these one-size-fits-all approaches.

The Benefits of a Structured Compensation Strategy

A structured compensation plan not only helps with compliance but also minimizes the risk of audits and ensures that you're fairly compensated for your efforts.

Determining your salary is more than just writing a paycheck—it's an essential part of running a compliant, audit-proof business. Take your role seriously and assess whether your compensation aligns with IRS standards. Consult a tax professional to review your compensation structure, ensuring it is defensible, fair, and strategic.