Five Reasons to Pay Yourself More (S Corp owner compensation strategies)

There is a lot of over-the-hedge tax strategy among small business owners. You know what I mean. Your neighbor who owns a painting company leans over the hedge and tells you he's paying zero taxes and you take his way of doing things and adopt them in your business. This happens quite often in the realm of officer compensation. S corp owners have the ability to limit the amount of payroll taxes they pay by reducing the salary they take out of the business. While good for cash flow there are a few reasons this may be a bad idea.

1. IRS is watching. S corporation owners are required to pay themselves a reasonable salary for personal services they perform for the business. If you don't IRS can come back and re-characterize distributions as wage payments. A host of underpayment and late penalties may follow. This is an area IRS has increasingly targeted for enforcement and even Congress is getting in on the act with recent legislative changes. It's better to have a well thought out and defensible compensation plan for the shareholders.


2. You may limit the amount you can contribute to retirement. Both defined benefit and defined contribution retirement plans are limited by the amounts you earn in wages. If your wages are too low you may be precluded from making contributions at the level that would be best for your financial plan.


3. You may sabotage your exit strategy. When someone looks at buying your business one of the first things they will use to torpedo your asking price is inadequate owner compensation. You at least want to have a debatable position rather than a scenario that is clearly flawed and gives the purchaser a clear point of leverage in the negotiations.


4. Inadequate officer compensation makes profit sharing muddy and confusing. The best profit sharing and incentive compensation plans use bottom line numbers from the financial statements. If you have to jump through hoops and explain why additional "below the line" adjustments are needed before you can communicate company profits you lose credibility with employees and make things more complicated than they should be.


5. Benchmarking becomes a black art. Similar to the problems created with profit sharing the presence of inadequate owner compensation in your financial statements makes it hard to compare your performance to peers or industry standards.

In the end inadequate shareholder compensation proves to be a nearsighted way to save a few tax dollars at the expense of sound business strategy.