Owners of S corporations have the dilemma of determining how much to pay themselves in salary and how much to take in distributions. Shareholders of S corporations are required to take a reasonable compensation for wages as defined by the IRS. There is a temptation for many small business owners of S corporations to take a small salary to save money on social security and medicare taxes and to maximize the new QBID or 20% deduction. It is important to be careful when determining salary and be sure that your compensation is not too small and it is reasonable. It does not always pay to underpay yourself.
First the IRS will require a reasonable salary be taken and can reclassify some of your distributions as wages which will cost you a lot of money in back taxes and penalties. Second don’t forget when paying into social security you are saving for your own retirement. You are only adding to your social security benefit by taking W-2 pages. Distributions do not add to your social security benefit. It is important to not take social security benefits for granted. Your benefit is calculated based on your average highest 35 years of W-2 wage earnings adjusted by an inflation index and using the AIME and PIA formulas. You don’t want the average of those 35 years to be so low that you have cheated yourself on social security benefits when you retire.
If you would like to meet with me to discuss what may be a reasonable compensation for you and understand how that compensation will affect both your taxes and your future social security benefit please call our office for an appointment. If you mention this blog you will receive a reduced rate of $75 (regularly $125) per hour for the appointment which normally does not take more than an hour.