What is your salary???

Question

My LLC that I set up to purchase rental properties took a turn for the better when I landed two flip deals instead. One was a SFR rehab and the other was a land flip. They were both great deals and will bring large chunks of cash. After discussing with my CPA we have decided to elect S Corp status for tax purposes. In the single member LLC with passive rental income I did not have to be concerned with a salary. However, in the S Corp I have to elect a "reasonable" salary and then I can take the rest of the profits as distributions as I see fit. So my question is if you are flipping or investing some other way using an S Corp how much do you pay yourself??

Disclaimer: I know you are not a CPA (and even if you are). I am not asking for tax advice. I'm just wondering what the community pays themselves. Thank You for any feedback you can provide.

Jason Rogers

Disclaimer: I know you are not a CPA (and even if you are). I am not asking for tax advice. I'm just wondering what the community pays themselves. Thank You for any feedback you can provide.

Jason Rogers

Jason Rogers · Answer

@Linda Weygant thank you for that very informative and well thought out response. It really made me think. We are looking at a gross profit approaching $180k. I would think that a $60k salary would be on the lower end of the range you mentioned but would still be reasonable based on cost of living and wages in my area. Thanks again!

Linda Weygant · Answer

Unfortunately, the IRS does not offer guidance on what they consider to be "reasonable" so as a CPA, we only have what we have seen pass through tax court to get a good understanding of what reasonable means.

There are many things that can affect "reasonableness" including length of time in business, relative experience of the person managing the business/project, etc.

In general, salaries that fall between 33% and 66% of overall profits are seen as being reasonable in past court cases and then a "sniff test" from there.

For example, I wouldn't recommend a 10% salary (per @Katie Neason above) unless that 10% then calculates out to something you might expect to pay a good project manager.  For example, if that 10% amount is $60,000 - $80,000, then I would classify that as reasonable.  But if that 10% salary is coming out at something less than $35,000 - $40,000, then it's really not reasonable as you wouldn't be able to go out into the open market and hire a decent project manager for that salary.  However, if the S-Corp Officer is really only overseeing a contractor or other project manager on a VERY part time basis, then something around $20,000 might be reasonable for an owner that is only checking in once a month or whatever.

The problem here is that it is VERY subjective.  Just because 10% works for Katie, does not mean that it would work for you.  It depends on overall profit levels (for example, a $50,000 salary on losses or profits less than $50,000 would not make sense).

So here's what I do...  Calculate out the profits and start with 50% as salary and 50% as Shareholder Distributions.  Slide the salary up or down based on other extenuating circumstances such as effort involved, overall profits and market factors.

Linda Weygant · Answer

I agree @jason - 60 definitely passes the sniff test and is likely pretty reasonable.

Katie Neason · Answer

We have the same set up to help minimize self employment taxes. We basically looked at the job of the LLC as a project manager so we asked a couple of local GC’s what they pay their project managers. We also were concerned with not knowing how many projects we would end up with in a year and not wanting to be stuck with a salary without income. We settled on a payment of 10% of our minimal project profit goal per project.

J Scott · Answer

First, everything that comes into your S-Corp flows through to your personal 1040, regardless of how much you decide to "pay yourself."  Doesn't matter if you take that money out of the S-Corp, leave it in the S-Corp, invest in something else, etc. -- 100% of it flows through to Line 17 of your 1040 as income as soon as your S-Corp earns it.

The decision on how much to pay yourself only serves to determine how much of the income you pay self-employment taxes on and how much is a distribution not subject to self-employment taxes.

And this is a question that boils down to risk versus reward -- the risk of an IRS audit and penalty versus the reward of paying less in self-employment taxes.  This is a decision that you should make based on discussions with your tax adviser, as he or she is likely the one that will need to help you support your decision should you be asked to justify that decision to the IRS.

Some tax advisers will pick a fixed percentage of the net income as your salary -- 60% is a number that I hear commonly.  Some will suggest surveying the industry and seeing what others who perform the same role and duties typically get paid.  Some will have a fixed number per industry.

Basically, there are a lot of ways to determine what your salary "should be" to both maximize tax benefits and minimize audit risk, but nobody here can tell you what that specific number is.

What is your salary???

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