The Man's Take

In our role as accountants and trusted advisors for our small business clients, one of the most frequent questions we hear is, "How much salary should I take from my business?" The answer isn’t as simple as it seems. How much salary you take depends largely on your corporate entity structure.

Most LLCs and partnerships and all sole proprietorships are entities in which the net profits of the business flow directly to the owner of the business. This net profit is considered the business owner’s salary, and is subject to all payroll taxes including FICA and Medicare tax. Although the net profit is considered salary, the business owner does not actually receive a W-2. The business owner must make quarterly estimated tax payments based on his or her projected share of the business income. We usually recommend setting aside approximately 35% to 40% of the salary for federal, state and local estimated tax payments. Not paying the correct amounts could result in interest and penalties.

The S-corporation owner is treated a little differently. Although considered an owner, he or she is also considered an employee for tax purposes. As an employee, the owner must receive a "reasonable" amount of salary and a W-2 at the end of the year, and not simply take all of his compensation in the form of a profit distribution. How much salary is reasonable is somewhat subjective.

The IRS doesn’t actually define what reasonable is; however, we have advised our clients to pay themselves a minimum salary of 30% to 40% of net profits. For example, if an S corporation has gross revenue of $150,000 and expenses of $50,000, the business owner should pay herself a salary of at least $30,000 or $40,000, which is deducted against net profits. Our office has experienced an increase in S-corp audits in which the IRS is looking to see that a business owner is taking a reasonable amount of salary. The salary of the owner of a C-corporation business is treated the same as that of any other employee: A W-2 is generated and all normal employment taxes are paid. As far as taxes are concerned, the owner’s salary can be set at any level.

When you’re deciding on your salary, pay attention to the requirements of your business entity, and balance business and personal considerations with tax considerations.