How much to pay yourself from a flip?

Question

Hello! We are about to close on a flip, and it's the first one that we set up as an LLC with S-corp tax. It is my husband, myself, and a partner as members of the LLC. How much can we "pay ourselves" from the profit to avoid additional taxes? Any advice would be most helpful! Thank you!

Shannon

Nicholas Aiola · Answer

@Shannon Cannon First of all, you have an awesome name!

Second, as @Ned Carey said, details matter. There's no such thing as a blanket, one-size-fits-all formula to use to calculate what's reasonable for S Corp shareholder salaries. 50% doesn't always work. What you should ask yourself (at least as a starting point) is "what would I pay someone else to do the work I did?". Keep in mind, when you're a one or two man show, you wear a lot of hats, so you're doing a million different jobs (deal finder, GC, secretarial work, etc.) - what's a "reasonable" amount to pay for these services?

S Corp shareholder wages has always been a highly scrutinized area and now, with the new tax law, will only get worse, thanks to Section 199A.

If ever questioned, you will need to explain how you arrived at a reasonable salary; simply saying 50/50 won't do. Not saying that 50/50 isn't okay in your case, just make sure you and your CPA have basis in that claim.

@Cody L. If you own an entity that's taxed as an S Corp, you are required to draw wages (payroll, salary, W-2 income, whatever you want to call it). Normal payroll taxes (namely FICA) are withheld from these payments. Profit distribution in excess of your wages are still taxed as ordinary income but escape self employment tax, which is 15.3% on top of income tax.

For example, let's say the profit from a flip is $100k and you draw $60k salary. Payroll taxes are being paid by the employee and employer (both you) on the $60k - they're being withheld from your check and remitted to the IRS and state taxing authority by the "employer" on behalf of you, along with the employer's own share.  The $40k is not subject to self-employment tax.

Wayne Brooks · Answer

@James Ma No, reinvesting the profit from a flip in an llc/Scorpio has No affect on the tax liability.  The goal here is to have part of the part of the profit taken as a “reasonable” salary (with as/med taxes) so the remainder of the profit is Not subject to ss/med taxes, just income tax.

James Ma · Answer

@Cody L. If she's got a business though she is able to reinvest any profits back into the company or she could buy stocks with it, etc. and wont need to claim income until its cashed out to herself I believe. Similar to RRSPs, you can pay yourself out slowly when you are older to reduce taxation.

Always good to check with an accountant to be sure what the rules and regulations in one's area is.

Ned Carey · Answer

@Shannon Cannon As I recall from my accountant 50% is a reasonable amount. However details matter.

If you have put little money into the company it can be argued that all profit is because of your efforts and most of the money is earned income subject to Self employment tax.

On the other hand if you have a significant number of employees and / or you invested significant money into the business it could be argued that the profits are coming primarily from you money invested or the employees.Therefore it would be reasonable that most of the profits come to you as dividends.  This is clearly something you need to discuss with a competent CPA.

David S. · Answer

@Shannon Cannon

Perhaps the accountants/CPA's can chime in, but you must pay yourself a "reasonable salary."  For example, if you did 100 hours of carpentry work on your flip and you found out that a carpenter makes on average of $25/hour in your area, then your salary for that aspect would be $2500.  Maybe you have below average skills in carpentry, so you elect to pay yourself $20/hour instead. You may have project manager hours to calculate as well.  In summary, you can't pay yourself $5000 a year if the average salary for that particular function is $50,000 a year.  Since you only did this work (flipping) for part (i.e. part-time) of the year, I would use the number of hours put in and what your research tells you is acceptable for a salary translated into an hourly wage.

Cody L. · Answer

I don’t use and am not setup as an S Corp. I figured that was a pretty small % of RE investors

Ned Carey · Answer

@Cody L. actually it does  matter in an S corp.  In an S corp as long as you pay yourself a "Reasonable Salary" then some profit can be distributed to you as dividends.  The difference is you only pay self employment tax on the Salary and not on the dividends. That says you about 14% on the part that comes to you as dividends.

You are a really smart and experienced guy. i am surprised you haven't heard of this before. Of course for rentals it  makes no difference because as "passive" income by IRS rules rents are not subject to self employment tax anyway.

Cody L. · Answer

I’m confused. “You” are going to make, from a tax standpoint, whatever profit was made from the flip.

If you buy for $100, put in $30, sell for $200, then you’ve made $70. Doesn’t matter if you pay yourself $70 or $10. You’re paying taxes on $70

Shannon Cannon · Answer

Thank you so much for your replies! I did speak with my accountant, and he suggested 50% dividends and 50% contributions-to be on the safe side. Thanks again!

How much to pay yourself from a flip?

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