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reasonable salary

RCReports Reasonable Salary Case Study

By Jason Watson, CPA

Posted Sun, October 13, 2019

Recently we had a foot and ankle physician group in Rhode Island complete two different RCReports interviews to determine a reasonable salary for their S Corp, and the results are worthy of further discussion. The first draft yielded a shareholder salary of $193,762 yet the second draft returned $112,728. That is an $81,000 difference!

What changed? Good question. Let’s recap a previous reasonable salary blog post where our wonderful Latesha Anderson walked you thru the methodology deployed by RCReports.

RCReports Methodology

Here is the blurb from our other blog post-

RCReports uses three methodologies to generate a report: Cost Approach, Market Approach, and Income Approach. The Market Approach and the Income Approach are typically used for larger companies or for businesses where there isn’t much data available to compare. The Cost Approach, aka the Many Hats Approach, is the one we see most commonly used for small, one-person or two-person, S Corps.

The Cost Approach analyzes the many duties a business owner completes and how much time is spent performing each task. It then determines a comparable wage for each duty and adds them up for a total cost to replace the services of the business owner. As a small business owner, you have to wear many hats; sometimes you’re the janitor, human resources, IT, etc. RCReports assigns a number to each task you perform and builds you up brick-by-brick until they determine a final salary of what it would cost to replace you and everything you bring to the S corporation.

Ok, so the reasonable salary methodology seems pretty straightforward, right? Cost, Market and Income are the common business valuation methodologies… why not use them for valuing shareholders? RCReports uses them in conjunction with IRS Fact Sheet 2008-25 and several other tax court cases.

How does RCReports take you, the shareholder, and funnels you thru the RCReports pinball machine of methodologies, and ultimately create reasonable salary number? It starts with some basic questions, and this is where the fun begins-

The RCReports process is very easy! RCReports sends you a link to complete a survey, you complete it, and it calculates what your reasonable shareholder salary should be! Bada-Bing-Bada-Boom! The survey begins by asking you

  • where you are located (state and county),
  • how many hours you work every week,
  • what standard tasks you do for your business (janitorial, administrative, marketing, finance, etc.), and
  • what business specific tasks you do.

There is one component that is not mentioned that is huge; we will drill down and show you how $193,762 went to $112,728. Wait for it…

RCReports Returns $193,762

Please check out the redacted RCReports Analysis of our foot and ankle physician group since you might find it useful as we take you through the reasonable salary components.

The first component you’ll notice is the hours worked which was 2,080. Most business owners recognize this number as 40 hours x 52 weeks. This makes sense if you are a full-time employee. But what if you as an S Corp shareholder don’t work a full 40-hour week?

The next component is the percentage of your time chopped up into a pie chart. Of your day or week, how much time is spent deploying your skills, and how much time is spent on-

  • administration,
  • training and continuing education,
  • janitorial duties,
  • talking to your amazing WCG CPAs,
  • discussing things with your attorney (yawn),
  • reviewing contracts (nighty night),
  • dealing with health insurance providers (shoot me now),
  • balancing your checkbook (less painful),
  • putting together that silly IKEA bookshelf and
  • several other things.

Don’t short-change yourself on the non-revenue generating tasks that you might do.

reasonable salaryThe final component in this analysis is proficiency. There are several options here, but the primary ones are above average and average. Every small business owner, especially doctors, think they are superman as compared to their peers. Sure… you’re special… but you are not unique. When using RCReports, we suggest checking the ego at the door and we’ll show you how this tiny change from above-average to average can alter the results dramatically.

As we stumble getting off our soapbox, let’s look at the next reasonable salary analysis.

RCReports Returns $112,768

In this report, all three components changed-

  • 2,080 hours went to 1,820 which is either 35 hours a week or just over 45 weeks per year.
  • Time spent went from 80% to 75% when the S Corp shareholders dug a little deeper into their time allocations.
  • Proficiency went from above-average to average. This was HUGE! It changed the hourly rate from $104 to $66.

So think of the pinball bouncing around in your RCReports pinball machine. The first bounce was reducing the hourly rate from $104 to $66. Next, the annual hours went from 2,080 to 1,820 given vacations, golfing, holidays and general screwing-around. Lastly, less time was spent performing doctor tasks (80% to 75%). In other words, the time spent was less valuable and the amount of time spent was reduced. Double dip!

Here is the combined RCReports for your edification-

reasonable salarySummary

RCReports is a garbage-in, garbage-out reasonable salary machine. This is true for so many things in life, right? So… as you work thru the interview questions keep the issues we highlighted in mind.

Another noteworthy consideration is that this report was performed for an S corporation physician group in Rhode Island. According to BestPlaces.net, Rhode Island has a 19% higher cost of living than the average for the United States. Housing, utilities and transportation were the major contributors. Interestingly, health costs were 80% of the United States average.

There ya go! If you need help sorting through all this and need to discuss reasonable salary for your S Corp, give us a call or send us an email. We would love to help!

Jason Watson, CPA is the Managing Partner of WCG Inc., a business consultation and tax preparation firm, and is the author of Taxpayer’s Comprehensive Guide on LLC’s and S Corps which is available online.