I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox π Also on YouTube at PlugAccountingandTax!
The Thing About S-Corp Salaries π«°
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Last couple of weeks we've been talking how to get your sh*t together π for year end tax planning. Today, we'll keep with that theme and go deep into an aspect of small business and private real estate tax that gets a lot of attention - S-Corp salaries. Not every small business should be a S-Corp, but once you get large enough (enough profit) it usually makes sense to have a S-Corp somewhere in the org chart. π And with that comes the requirement to pay yourself, the owner, a reasonable salary. Let's go. β€΅οΈ A Little Context2017 tax reform (TCJA) changed the game on S-Corp salaries. TCJA introduced the qualified business income (QBI) deduction with income phaseouts that could be overridden with enough W2 salaries. But I'm getting ahead of myself. Prior to 2017 changes (yes I've been around that long πΎ), the game on S-Corp salary was to pay as little as possible. Every dollar taken out a S-Corp profit distribution instead of S-Corp salary would save you 15.3% up to approx. $150k (back then) and then approx. 3.8% on anything above that. So on a profitable business of say $500k, having a S-Corp that paid a $50k salary (prob. too low) would save you approx. $30k a year in self-employment tax. The IRS knew that so occasionally they would run a compensation audit if a super profitable business showed too little compensation to officers - an easy read from Page 1 of the S-Corp return. QBI Strategy and SalariesAfter 2017, the self-employment tax savings needed to be balanced with optimizing the QBI deduction βοΈ - 20% of eligible pass-through income. If you were either (1) under the income phaseout, or (2) a disqualified type of business (doctors, lawyers, me π₯) - the self-employment tax savings was still the main play. But owners of eligible businesses discovered they could actually increase their overall net tax savings by paying themselves MORE salary. An example: A (non-SSTB) S-Corp that makes $1 million in profit
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Owner used to pay himself $100k. Saved himself like $30-$40k a year of SE Tax.
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But under the new rules, his max QBI deduction would be $200k! Or like $70k at the top brackets.
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This max QBI deduction, however, gets limited by how much W2 was paid - specifically 1/2 of W2 wages paid.
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So under the $100k salary he paid, he only got a QBI deduction of $50k - womp womp.
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But if instead he had paid himself 29% of pre-salary income, he'd optimize QBI perfectly.
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$1,000,000 x 29% = $290,000 salary
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Net max QBI benefit = $1,000,000 - $290,000 = $710,000 x 20% = $142,000 QBI deduction
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QBI deduction of $142,000 can't be over 1/2 of W2 wages paid, or $290,000 / 2 = $145,000. Perfect.
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S-Corp owner still saves SE tax on the $710,000 net profit. And gets an additional $145,000 QBI deduction.
Your takeaway from this is that there is a magic number to hit to optimize QBI for non-SSTB businesses. It's 29% π of pre-owner W2 income. Edge Cases and CaveatsOkay that's the alpha - but a few things need to be said still. First, this still has to pass the reasonable compensation test. π The amount of compensation paid to a business owner for their work in the business has to be defensible from either side - too low or too high. Second, some businesses don't really need this. If you already employ people and pay them wages, you get credit (as the owner) for those wages. So factor this all in before running your payroll. π€·ββοΈ Last one - watch for impacts on retirement planning. Things like SEP contributions work off of how much W2 wages you pay yourself. So if you are used to maxing out those contributions, this will layer in complexity to that calculation. The TakeawayRunning a salary as an owner of a S-Corp is a non-negotiable. Part of the hassle of tax efficiency. But there are ways to use it to your advantage to get the most out of it. Run the calculations weighing all the factors and enjoy staying rich. π«‘ Group Chat Worthy Posts π₯π²
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I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox π Also on YouTube at PlugAccountingandTax!
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