Balancing Passion, Paperwork, and Profitability

As a small business owner, you're juggling a lot—passion, profitability, and paperwork. Amid all this, figuring out how much to pay yourself can be bewildering. But it’s not a decision you should leave to guesswork. How you pay yourself affects everything from tax compliance to your business's long-term health.

A Reasonable Compensation Analysis: What Is It?

A reasonable compensation analysis is a structured approach to figuring out an appropriate, IRS-compliant salary. It considers factors such as the roles you perform, the time you invest in your business, industry salary benchmarks, and regional data. This method helps ensure that your salary is appropriate and defendable in the eyes of tax authorities.

Don't Rely on Shortcuts

Many business owners are tempted by shortcuts like the "60/40 rule," taking small salaries and large distributions to minimize taxes. However, the IRS doesn’t accept one-size-fits-all solutions. A structured compensation strategy is your best bet to stay compliant and reduce audit risks. It not only aligns with IRS standards but ensures you're fairly compensated for your hard work.

The Dangers of Paying Yourself Too Little

Paying yourself too little has its downsides. You could face reclassified distributions, back taxes, penalties for employment tax errors, or even risk losing your S corporation status. Proper compensation isn't just a paycheck; it's part of a compliant, audit-proof business strategy.

IRS Criteria for Reasonable Compensation

The IRS uses several criteria to evaluate reasonable compensation. It looks at your background, job responsibilities, business profitability, workplace dynamics, wages paid to comparable employees, and historical compensation structures. Ensuring your salary reflects these criteria can protect you from costly mistakes down the line.

The Protective Power of a Structure

Having a structured compensation plan offers a protective buffer. It aids compliance, minimizes the likelihood of audits, and assures that your compensation is fair and defensible. This structure is crucial for both your peace of mind and your business's stability.

Make Your Salary a Priority

Your salary isn't just about drawing a paycheck—it's a critical part of running a compliant and audit-proof business. Assess whether your current compensation meets IRS standards and consult a tax professional or advisor. This ensures your structure is fair, defensible, and strategic. Take your role seriously: your business's future depends on it.