Transcript
If you run your business as an escorp, there's one rule you cannot ignore, and that is paying yourself a reasonable salary. Get it wrong, and the IRS could come knocking. Today, I'll explain what a reasonable salary is, why it matters, and how it applies to everyone from a high earning medical professional to a small freelance videographer. In simple terms, the reasonable salary is the amount you would pay someone else to do the same job in the same situation. And this is important because you have to pay payroll taxes of 15.3% on that reasonable salary amount that you set for yourself. Here, the IRS expects you to fairly compensate yourself for the work you actually perform. And to illustrate this concept, I'll use an example. Imagine you're a successful physician making $400,000 a year through your practice that's structured as an escorp. You can't just take all of that as distributions to avoid paying payroll taxes. The IRS requires you to set a reasonable salary for your work. And a reasonable salary might be, say, $250,000. what other physicians with your training, experience, and workload would earn in the market. Here's the benefit of doing this. You only pay the 15.3% in payroll taxes on that reasonable salary amount. Now, if you don't set a salary for yourself, you pay 15.3% on the $400,000 that you generate. So, here you'd be paying a little north of $61,000. But if you set a reasonable salary of $250,000, you only pay the 15.3% on that $250,000. So in other words, you'd be paying about $38,000 in payroll taxes. So in this example, you can save over $20,000 in payroll taxes. And as an added benefit, the other $150,000 after any business expenses could be taken as distributions which are not subject to payroll taxes. So why do you need a reasonable salary? The reasonable salary rule is about striking the right balance enough to reflect your work, but not so much that you're wasting your money on unnecessary payroll taxes. Set your salary too high and you'll overpay in social security and Medicare taxes that come from your payroll taxes. Set it too low and the IRS may reclassify your distributions as wages. Hit you with back taxes, interest, and penalties. Here's the bottom line. If you're running an escorp, don't ignore reasonable compensation. Think about what someone in your field with your responsibilities would earn. Whether you're a doctor making hundreds of thousands or a small business owner running a small shop, if you found this helpful, hit the like button, subscribe for more small business tips, and drop a comment with your escorp questions below. If you need help forming the entity, my team at Corporate Direct would be happy to assist you. You can schedule a free 15minute consult by clicking the link in the video description below. [snorts]