What you need to know
When you actively operate under an S Corp election and take owner distributions, the IRS requires you to pay yourself a reasonable salary, reflective of what someone in your position would earn. However, defining 'reasonable' can be a bit tricky since the IRS doesn't provide explicit guidelines. Instead, they consider each case based on its specific facts and circumstances.
Let's break down this process to make it a bit less daunting and ensure you feel confident in your decision.
Determining Reasonable Salary with Collective
At Collective, we take a supportive approach rather than prescribing a specific number. We understand that every business is unique, so we suggest a salary range based on:
- Expected Profit: Though the IRS does not prescribe to any formulas surrounding reasonable comp and profit, it’s a factor we consider when we help you establish a salary range. We look at your expected profit over the next 12 months to help guide your decision
- Comparable Salary based on Current Industry Standards: Consider what similar positions pay in your region, whether you work full-time or part-time, your experience or seniority in the given role and benchmark salaries according to IRS guidance and broader market research
This approach allows you to weigh your total income against your salary to find a balance that feels right for you and is justifiable under IRS rules.
Guiding Principles in Salary Selection
We recommend researching what similar roles pay based on where you live. It’s also important to consider your total income in comparison to your salary. From there, you can determine the reasonableness of your selection or update it given any new information.
As a small business, it would be understandable that a salary at one company might be too large of an expense for your business to pay. Remember to keep your expected profit in mind when making decisions on your compensation and set a salary that aligns with your comfort level.
At the end of the day, you are the business owner, and the final decision regarding your salary is entirely up to you.
Let’s Review Your Reasonable Compensation
At the end of the day, you are the business owner, and the final decision regarding your salary is up to you.
Flexibility & Adjustments
Your chosen salary isn't set in stone. As your business evolves, you may find that you need to adjust your compensation. Whether it’s increasing your salary to match business growth or skipping a payroll run during slower periods.
How Collective Helps
Collective will provide a recommended salary range and help you set up your payroll, but ultimately you get to decide where you want your salary to land. Our role is to empower you with information and support, so you can make the best decisions for your business.
If you need more guidance, don’t hesitate to reach out.
Disclaimer: The information contained in this document is provided for informational purposes only and should not be construed as legal, financial, or tax advice. It is not intended to be a substitute for obtaining legal, accounting, or other financial advice from an appropriate and/or licensed adviser, or for the purpose of avoiding U.S. Federal, state or local tax payments and penalties.