Taxpayers Guide to LLCs and S Corps
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S Corp Salary Starting Point
By Jason Watson, CPA
Posted Friday, October 8, 2021
There are plenty of professions that have great data from the Bureau of Labor Statistics (BLS), Risk Management Association (RMA) or RCReports. But let’s say your job is some odd-duck, whacky thing for which comparable data doesn’t exist. Where do we start quantitatively? At the end of the day, we need a number!
One argument that we and others have made is the concept of 1/3, 1/3, 1/3-
- 1/3 paid as shareholder salary, plus
- 1/3 retained for expenses (if necessary, otherwise flushed out at end of quarter), plus
- 1/3 distributed as return on investment (distributions)
Where the heck did we get this? A rule of thumb for service trades or businesses such as accountants, attorneys, consultants and the usual suspects is to bill three times the salary. For example, if WCG pays a CPA $80,000 per year we hope to bill $240,000. 1/3 of this goes to salary, 1/3 goes to expenses and 1/3 goes to Jason’s new boat in a land-locked state. Most professional firms should have net profits of about 30 to 35%
Sidebar: This is why CPA firms sell for about 1.0 to 1.1 times gross revenue. This translates to a 3-year payback period at 100% retention or about 5-6 years with the usual 60% retention. This is acceptable return on investment as compared to other investments and the accounting industry. Remember the rule of 72? Divide 72 by the rate of return, and that is your payback period (or the time it takes to double your money… same thing). 72 divided by 6 is still 12% which is not supper great given the risk (oh well). We digress…
Even if your profession is easily teased out from labor data, this 1/3 concept can still be used. The middle 1/3 above is allocated to expenses- why should you be penalized for running a leaner, meaner firm than the bloated clowns down the street?
Using the 1/3 concept is just a starting point- since we have to start somewhere, using a mathematical formula makes it easy. From there, similar to the “plus” and “minus” approach by the IRS and Tax Court judges, we massage this salary to be reasonable for you and your business’s situation.
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