Reasonable salary question with a twist [S Corp]

[nplusone]

I have a S corp with just husband-wife as employees and shareholders.

Here is how things were before

Code: Select all

  500k  S corp operating profit before salary and benefits
- 280k  w2 salary (240 for me; 30k for spouse)
-  70k  401k contributions 
-  14k  employer FICA + other taxes
---------
 136k  K1 distribution

I had a high salary; lower K1 so I kept IRS happy.

But now I have a Defined Benefit plan.
The new numbers are

Code: Select all

  300k  S corp operating profit before salary and benefits (revenue has gone down)
- 180k  Defined Benefit Plan contribution
-  55k  W2 salary (30k for me; 25k for spouse)
-   3k  Solo 401k contribution
-   4k  Employer FICA + other taxes
-------
   59k  K1 distribution

1) Is the new salary resonable?

2) If the revenues drop even futher next year, I might be able to take just $25k on W2 and 20k in distributions. Will IRS complain that as a sole breadwinner of a company that has $230k operating profit, a salary of $25k is unreasonable?

In my opinion it is resonable. If a company were to offer me a job of $25k salary with $180k contribution to retirement account, I would take it. I can live off dividend income so I don't need the salary in hand. I would rather save on taxes.

Any thoughts please?

[Title clarified by moderator Kendall.]

[MP123]

Since there's no formal definition of "reasonable compensation" it's hard to say for sure.

The whole point is to ensure that FICA taxes are paid on compensation rather than just slipping money out of the S-Corp as a distribution without FICA. Are you (or will you) be paying FICA on either the contributions or distributions for the DB plan?

[Commonstalk]

The IRS has no concrete instructions on what Reasonable Compensation should be for S or C Corp owner/employees, only somewhat sloppy guidance. There is a company that has developed a software to help you to come to a Reasonable conclusion. It's RCReports and is only available through tax professionals, to my knowledge.
The software, for the most part, has been developed from Tax Court cases. I, for one, won't take on a Corp client without the owner/employees using the software to determine their specific RC. You'll feel much more at ease and relieved if you can find a way to use it for your circumstance.

[nplusone]

Since there's no formal definition of "reasonable compensation" it's hard to say for sure.

The whole point is to ensure that FICA taxes are paid on compensation rather than just slipping money out of the S-Corp as a distribution without FICA. Are you (or will you) be paying FICA on either the contributions or distributions for the DB plan?

DB plan is similar to the 401k plan.
There is no FICA on contributions.
The distributions are taxed as income (similar to 401k) but no FICA.

[KlangFool]

Since there's no formal definition of "reasonable compensation" it's hard to say for sure.

The whole point is to ensure that FICA taxes are paid on compensation rather than just slipping money out of the S-Corp as a distribution without FICA. Are you (or will you) be paying FICA on either the contributions or distributions for the DB plan?

DB plan is similar to the 401k plan.
There is no FICA on contributions.
The distributions are taxed as income (similar to 401k) but no FICA.

OP,

The bigger picture question is why is this better for you.

Social Security is a good deal especially when someone has not reach the first bend point. Have you calculated what do you lose in terms of social security benefits by doing this?

KlangFool

[Pdxnative]

I’m not an expert on this but work with my CPA to arrive at a number that is reasonable and I can defend with a straight face.

To me as a layperson, that sort of cut in salary for the same role seems like it’s a red flag. As I understand it, claiming that you can pay someone income but shield it from taxes isn’t evidence that the w2 wages are reasonable. It’s evidence that you’re doing what the IRS thinks you shouldn’t.

Did you ask your accountant?

[inverter]

This does not pass the smell test.

[MP123]

Since there's no formal definition of "reasonable compensation" it's hard to say for sure.

The whole point is to ensure that FICA taxes are paid on compensation rather than just slipping money out of the S-Corp as a distribution without FICA. Are you (or will you) be paying FICA on either the contributions or distributions for the DB plan?

DB plan is similar to the 401k plan.
There is no FICA on contributions.
The distributions are taxed as income (similar to 401k) but no FICA.

I haven't heard of reasonable comp cases involving DB plans, but that doesn't mean there aren't any.

The usual case is someone taking a very low salary (like yours) with six-figure distributions. Except you're putting most of what would be distribution into a DB plan instead. Perhaps you could argue that the DB plan is compensation (just not ever subject to FICA) that should be added to your salary, but I'm not sure about that. With the amounts/ratios stated this setup "feels" a little aggressive, to me at least.

Have you got a professional opinion on this yet?

[nplusone]

Since there's no formal definition of "reasonable compensation" it's hard to say for sure.

The whole point is to ensure that FICA taxes are paid on compensation rather than just slipping money out of the S-Corp as a distribution without FICA. Are you (or will you) be paying FICA on either the contributions or distributions for the DB plan?

DB plan is similar to the 401k plan.
There is no FICA on contributions.
The distributions are taxed as income (similar to 401k) but no FICA.

OP,

The bigger picture question is why is this better for you.

Social Security is a good deal especially when someone has not reach the first bend point. Have you calculated what do you lose in terms of social security benefits by doing this?

KlangFool

This is why I come to this forum. The advice/information is far better than commercial CPAs who are just paper pushers.

Thank you Klang. I had not thought of lower SS benefits.

I used the online calculator at SSA.gov to simulate future benefits with an avg of $30k and $100k salary from now till retirement.
The difference in benefits is approx $3400. Assuming I draw the benefits for 20 years, it represents an annuity of $21k in today's dollars (based on https://www.schwab.com/annuities/fixed- ... calculator).
This assumes that SSA pays full benefits till 2058..which is unlikely.

But lowering salary by 70k saves me 30k today in FICA+income taxes.
So lower salary works out better.

A) Is my conclusion valid?
B) Similar to SS benefits, what other factors have I missed considering?

[nplusone]

Have you got a professional opinion on this yet?

I have had very bad luck with supposed professionals.
I have tried 3 different CPAs in the past. They just open some software and plug in numbers. I have had to correct their mistakes.
And they were not cheap.
I once went to a big shop - a huge office in a fancy suburb multiple CPAs. They had a cube farm just for the support staff.
They charged 3400 for 1040 and 1120. This did not include payroll forms or payroll calculations.
But they screwed up multiple times; refused to accept responsibility.

Two different CPAs included subcontractor payments as W2 wages in 199A calculations. This resulted in incorrect 199A deduction.
One guy's staff entered incorrect number for SUTA calculations.

In my experience, I find better information/advice on this forum.

[KlangFool]

This is why I come to this forum. The advice/information is far better than commercial CPAs who are just paper pushers.

Thank you Klang. I had not thought of lower SS benefits.

I used the online calculator at SSA.gov to simulate future benefits with an avg of $30k and $100k salary from now till retirement.
The difference in benefits is approx $3400. Assuming I draw the benefits for 20 years, it represents an annuity of $21k in today's dollars (based on https://www.schwab.com/annuities/fixed- ... calculator).
This assumes that SSA pays full benefits till 2058..which is unlikely.

But lowering salary by 70k saves me 30k today in FICA+income taxes.
So lower salary works out better.

A) Is my conclusion valid?
B) Similar to SS benefits, what other factors have I missed considering?

nplusone,

"I used the online calculator at SSA.gov to simulate future benefits with an avg of $30k and $100k salary from now till retirement."

1) That is the wrong way to calculate this.

2) The correct question is whether you and your spouse had reached the first bend point or not. Or, the second bend point?

3) What is the total social security taxed earning for you and your spouse individually so far?

4) You could find out the number from you and your spouse's annual social security report.

https://www.amazon.com/Social-Security- ... C87&sr=8-4

5) You should get the above. It is only $5 for the kindle version.

https://www.ssa.gov/oact/cola/bendpoints.html

6) The first bend point is around $1k. It translates approximately to 35X 12 X 1K = 420K of social security taxed earning. Before the first bend point, the amount is credited 90%.

7) Essentially, it is worthwhile to at least have about 420K worth of social security taxed earning for at least you and perhaps your spouse.

https://www.ssa.gov/oact/progdata/retirebenefit2.html

KlangFool

[KlangFool]

Since there's no formal definition of "reasonable compensation" it's hard to say for sure.

The whole point is to ensure that FICA taxes are paid on compensation rather than just slipping money out of the S-Corp as a distribution without FICA. Are you (or will you) be paying FICA on either the contributions or distributions for the DB plan?

DB plan is similar to the 401k plan.
There is no FICA on contributions.
The distributions are taxed as income (similar to 401k) but no FICA.

OP,

The bigger picture question is why is this better for you.

Social Security is a good deal especially when someone has not reach the first bend point. Have you calculated what do you lose in terms of social security benefits by doing this?

KlangFool

This is why I come to this forum. The advice/information is far better than commercial CPAs who are just paper pushers.

Thank you Klang. I had not thought of lower SS benefits.

I used the online calculator at SSA.gov to simulate future benefits with an avg of $30k and $100k salary from now till retirement.
The difference in benefits is approx $3400. Assuming I draw the benefits for 20 years, it represents an annuity of $21k in today's dollars (based on https://www.schwab.com/annuities/fixed- ... calculator).
This assumes that SSA pays full benefits till 2058..which is unlikely.

But lowering salary by 70k saves me 30k today in FICA+income taxes.
So lower salary works out better.

A) Is my conclusion valid?
B) Similar to SS benefits, what other factors have I missed considering?

OP,

Until you cross the first bend point at about 420K of social security taxed earning,

For 100K of social security taxed earning, you pay about 15K in FICA taxes. It is credited 90%.

100K /35/12 = $238

$238 X 90% = $214.2 per month. And, this amount is adjusted by inflation rate every year.

Why is this not a great deal?

The number is simplified and approximated. To get an accurate estimate, you need to use a better tool.

KlangFool

[Nate79]

Is that a reasonable salary to do the job you do or not? Looks pretty low to me, is it working at McDonalds?

[nplusone]

This is why I come to this forum. The advice/information is far better than commercial CPAs who are just paper pushers.

Thank you Klang. I had not thought of lower SS benefits.

I used the online calculator at SSA.gov to simulate future benefits with an avg of $30k and $100k salary from now till retirement.
The difference in benefits is approx $3400. Assuming I draw the benefits for 20 years, it represents an annuity of $21k in today's dollars (based on https://www.schwab.com/annuities/fixed- ... calculator).
This assumes that SSA pays full benefits till 2058..which is unlikely.

But lowering salary by 70k saves me 30k today in FICA+income taxes.
So lower salary works out better.

A) Is my conclusion valid?
B) Similar to SS benefits, what other factors have I missed considering?

nplusone,

"I used the online calculator at SSA.gov to simulate future benefits with an avg of $30k and $100k salary from now till retirement."

1) That is the wrong way to calculate this.
2) The correct question is whether you and your spouse had reached the first bend point or not. Or, the second bend point?
3) What is the total social security taxed earning for you and your spouse individually so far?
4) You could find out the number from you and your spouse's annual social security report.
https://www.amazon.com/Social-Security- ... C87&sr=8-4
5) You should get the above. It is only $5 for the kindle version.
https://www.ssa.gov/oact/cola/bendpoints.html
6) The first bend point is around $1k. It translates approximately to 35X 12 X 1K = 420K of social security taxed earning. Before the first bend point, the amount is credited 90%.

7) Essentially, it is worthwhile to at least have about 420K worth of social security taxed earning for at least you and perhaps your spouse.

https://www.ssa.gov/oact/progdata/retirebenefit2.html

KlangFool

According to the SS statement, Earnings Taxed for Social Security are $2.4m and I have paid $135k in SS taxes. Employer(s) have paid $133k.

According to https://www.whitecoatinvestor.com/socia ... nd-points/, the 2nd bend point is $2.6m.
I am 52 and I plan to work at least 15 years. So even with lower salaries, I will reach the 2nd bend point.

[KlangFool]

This is why I come to this forum. The advice/information is far better than commercial CPAs who are just paper pushers.

Thank you Klang. I had not thought of lower SS benefits.

I used the online calculator at SSA.gov to simulate future benefits with an avg of $30k and $100k salary from now till retirement.
The difference in benefits is approx $3400. Assuming I draw the benefits for 20 years, it represents an annuity of $21k in today's dollars (based on https://www.schwab.com/annuities/fixed- ... calculator).
This assumes that SSA pays full benefits till 2058..which is unlikely.

But lowering salary by 70k saves me 30k today in FICA+income taxes.
So lower salary works out better.

A) Is my conclusion valid?
B) Similar to SS benefits, what other factors have I missed considering?

nplusone,

"I used the online calculator at SSA.gov to simulate future benefits with an avg of $30k and $100k salary from now till retirement."

1) That is the wrong way to calculate this.
2) The correct question is whether you and your spouse had reached the first bend point or not. Or, the second bend point?
3) What is the total social security taxed earning for you and your spouse individually so far?
4) You could find out the number from you and your spouse's annual social security report.
https://www.amazon.com/Social-Security- ... C87&sr=8-4
5) You should get the above. It is only $5 for the kindle version.
https://www.ssa.gov/oact/cola/bendpoints.html
6) The first bend point is around $1k. It translates approximately to 35X 12 X 1K = 420K of social security taxed earning. Before the first bend point, the amount is credited 90%.

7) Essentially, it is worthwhile to at least have about 420K worth of social security taxed earning for at least you and perhaps your spouse.

https://www.ssa.gov/oact/progdata/retirebenefit2.html

KlangFool

According to the SS statement, Earnings Taxed for Social Security are $2.4m and I have paid $135k in SS taxes. Employer(s) have paid $133k.

According to https://www.whitecoatinvestor.com/socia ... nd-points/, the 2nd bend point is $2.6m.
I am 52 and I plan to work at least 15 years. So even with lower salaries, I will reach the 2nd bend point.

That means you probably have reached the second bend point. How about your spouse?

It means it does not make sense for you to pay a lot more social security taxes.

KlangFool

[nplusone]

Is that a reasonable salary to do the job you do or not? Looks pretty low to me, is it working at McDonalds?

Hmm - If McD pays $25k and puts $180k in IRA, that's not too bad. I would take it. In fact, I would prefer it over getting $205k in salary.

[Jack FFR1846]

Is that a reasonable salary to do the job you do or not? Looks pretty low to me, is it working at McDonalds?

This is what I was thinking. My son just started for a contractor with Amazon as a sole client. He's a high school graduate. He's making $62,400 with guaranteed increases in time sections. $30k would tell me school dropout with a felony conviction.

[nplusone]

This is why I come to this forum. The advice/information is far better than commercial CPAs who are just paper pushers.

Thank you Klang. I had not thought of lower SS benefits.

I used the online calculator at SSA.gov to simulate future benefits with an avg of $30k and $100k salary from now till retirement.
The difference in benefits is approx $3400. Assuming I draw the benefits for 20 years, it represents an annuity of $21k in today's dollars (based on https://www.schwab.com/annuities/fixed- ... calculator).
This assumes that SSA pays full benefits till 2058..which is unlikely.

But lowering salary by 70k saves me 30k today in FICA+income taxes.
So lower salary works out better.

A) Is my conclusion valid?
B) Similar to SS benefits, what other factors have I missed considering?

nplusone,

"I used the online calculator at SSA.gov to simulate future benefits with an avg of $30k and $100k salary from now till retirement."

1) That is the wrong way to calculate this.
2) The correct question is whether you and your spouse had reached the first bend point or not. Or, the second bend point?
3) What is the total social security taxed earning for you and your spouse individually so far?
4) You could find out the number from you and your spouse's annual social security report.
https://www.amazon.com/Social-Security- ... C87&sr=8-4
5) You should get the above. It is only $5 for the kindle version.
https://www.ssa.gov/oact/cola/bendpoints.html
6) The first bend point is around $1k. It translates approximately to 35X 12 X 1K = 420K of social security taxed earning. Before the first bend point, the amount is credited 90%.

7) Essentially, it is worthwhile to at least have about 420K worth of social security taxed earning for at least you and perhaps your spouse.

https://www.ssa.gov/oact/progdata/retirebenefit2.html

KlangFool

According to the SS statement, Earnings Taxed for Social Security are $2.4m and I have paid $135k in SS taxes. Employer(s) have paid $133k.

According to https://www.whitecoatinvestor.com/socia ... nd-points/, the 2nd bend point is $2.6m.
I am 52 and I plan to work at least 15 years. So even with lower salaries, I will reach the 2nd bend point.

That means you probably have reached the second bend point. How about your spouse?

It means it does not make sense for you to pay a lot more social security taxes.

KlangFool

Spouse is slightly above 1st end point. There is no way she will reach 2nd end point even after 12 years. And it will be hard for me to justify a higher salary for her.

[nplusone]

Is that a reasonable salary to do the job you do or not? Looks pretty low to me, is it working at McDonalds?

This is what I was thinking. My son just started for a contractor with Amazon as a sole client. He's a high school graduate. He's making $62,400 with guaranteed increases in time sections. $30k would tell me school dropout with a felony conviction.

I think you are missing the $180k per year contribution to what is essentially an IRA.

[LotsaGray]

Reasonable depends on what you would be paid going same job working for someone else. So if you could make $50/hr doing same thing as an employee of done one then $100K would def be reasonable but $25k probably not. Depends how IRS feels.

[nplusone]

I think essentially the quesiton boils down to
Say you have 2 job offers.
One pays $205k/year. You pay FICA and Income tax.
Another offer pays $25k/year and employer puts $180k in your IRA.

Assuming you don't need the money now, would you discard the 2nd offer?

Especially in our situation, the entire $205k is going either to heirs or charity.
Dividends in our taxable accounts are close to $80k which is enough for our lifestyle.

[MP123]

Say you have 2 job offers.
One pays $205k/year. You pay FICA and Income tax.
Another offer pays $25k/year and employer puts $180k in your IRA.

I respectfully point out that it would be illegal for the employer to do so, which brings us back around to whether the DB plan is compensation, and, if so, how much.

[nplusone]

Say you have 2 job offers.
One pays $205k/year. You pay FICA and Income tax.
Another offer pays $25k/year and employer puts $180k in your IRA.

I respectfully point out that it would be illegal for the employer to do so, which brings us back around to whether the DB plan is compensation, and, if so, how much.

MP123, you won't hurt my feelings if you call me an idiot as long as you point out where I am wrong. So no worries there.

A Defined Benefit plan in a shareholder owned S Corp is typically rolled over into an IRA at the end of the employment.
Therefore I used the term IRA for simplicity's sake but I now understand it is misleading. My apologies.
Yes - it is illegal for employer to contribute to IRA.

A better verbiage would have been
Second offer pays $25k/year but offers extremely generous guranteed pension which is worth $180k/year in today's dollars.
And it allows you to save $30k/year on taxes.

Would you take the 2nd offer?

Edit: Mp123, do you think it would still be illegal?

[nplusone]

Maybe I am comparing apples and oranges.
But Buffett takes a salary of $100k. Steve Jobs used to take a salary of one dollar.

But they were compensated in different ways.
Same here - I am taking a low salary but getting compensated by an extremely geneours pension.

Edit: Thanks to lotsagray comment, I now realize that this is an imperfect analogy. I overlooked the fact that Apple/BRK are C corps.

[MP123]

The second offer is obviously more attractive. Just not sure if the contribution to the DB plan would be considered compensation.

If it was a DC plan it might be more clear cut, certainly if it was an employee contribution. But whether the actuary calculated (I assume) contribution to the DB plan is compensation or if it's the eventual benefit itself that counts seems a little ambiguous.

[nplusone]

Sometimes writing in First Person on such topics makes the post appear in a differnt color.

Would it help if I frame it as

I am a CPA. My s corp client has the following on 1120S

$25k Line 7=> Compensation of officers
$180k Line 17 => Pension, profit-sharing, etc., plans
$30k Line 21 => Ordinary business income

Is this a problem?

Edit: I wrote this post poorly. I am NOT a CPA.

[nplusone]

The defined benefit plan is a retirement plan established by the company for the benfit of its employees.
If the mandatory contributions are high, then there is very little money left for salary/distribution.

This is similar to pre-Obamacare days.
Imagine that the S Corp established a health insurance plan for its 2 employees.
And next year, one employee was diagnosed with cancer and needed ICU 24x7. The insurance company paid out hundreds of thousands and hence immediately jacked up the health premium to insane levels.
The S Corp still has to pay those premiums and there is very little money left for salary/distributions.

Edit: Thanks to Lotsofgray's response , I realize this analogy is somewhat flawed. So please ignore this post.

[MP123]

$25k Line 7=> Compensation of officers
$180k Line 17 => Pension, profit-sharing, etc., plans
$30k Line 21 => Ordinary business income

Is this a problem?

Not sure if it's a problem. But it does look like it might attract some attention.

[LotsaGray]

Sometimes writing in First Person on such topics makes the post appear in a differnt color.

Would it help if I frame it as

I am a CPA. My s corp client has the following on 1120S

$25k Line 7=> Compensation of officers
$180k Line 17 => Pension, profit-sharing, etc., plans
$30k Line 21 => Ordinary business income

Is this a problem?

Could you get a CPA with your level of experience to work for you for $25K? If yes then your salary seems reasonable but I doubt you can answer honestly yes.

[vnatale]

Here is the as usual thorough treatment from Kitces of analyzing Sub S Dividends and its effect on Social Security.

I need to think more about the actual question you have asked.


https://www.kitces.com/blog/s-corporati ... rity-fica/

[vnatale]

I also will first go to see what the IRS has to say:

https://www.irs.gov/businesses/small-bu ... reasonable

[vnatale]

Another view:

https://www.picpa.org/articles/cpa-now- ... xplanation

[LotsaGray]

The defined benefit plan is a retirement plan established by the company for the benfit of its employees.
If the mandatory contributions are high, then there is very little money left for salary/distribution.

This is similar to pre-Obamacare days.
Imagine that the S Corp established a health insurance plan for its 2 employees.
And next year, one employee was diagnosed with cancer and needed ICU 24x7. The insurance company paid out hundreds of thousands and hence immediately jacked up the health premium to insane levels.
The S Corp still has to pay those premiums and there is very little money left for salary/distributions.

Your health insurance analogy fails in multiple ways but you don’t seem open to the input being provided. BTW any Jobs, Gates, Musk Buffet or similar comps also fail simply because they are C corps.


Will try again in a different way… paying out 10% of corp net as salary it is probably not going to fly with IRS. But if you are a CPA I am surprised you don’t know all of this.

[vnatale]

Another view which also has a tool for sale for $175:

https://amynorthardcpa.com/s-corporatio ... pensation/

[vnatale]

Another tool here:

https://wageoptimizer.com/

[vnatale]

This is an older article but I'm sure all its principles still apply. It goes through several court cases in detail.


https://www.thetaxadviser.com/issues/20 ... g2011.html

[vnatale]

Sometimes writing in First Person on such topics makes the post appear in a differnt color.

Would it help if I frame it as

I am a CPA. My s corp client has the following on 1120S

$25k Line 7=> Compensation of officers
$180k Line 17 => Pension, profit-sharing, etc., plans
$30k Line 21 => Ordinary business income

Is this a problem?

I tried and tried to find something that included having a Defined Benefit plan as part of the reasonableness but could not find anything. You saw what I provided, which may be useful to you.

I do not think the CPA would have a problem.

The before options income was $235,000.

The decision is made to have a legitimate deductible expense of $180,000 for a Defined Benefit plan. That leaves $55,000 to be split between Officer compensation and Sub-S Dividends.

Your proposal is close to a 50 / 50 split of that remaining $55,000. At that level of amount to be divided by the two options I would not expect the IRA to object to what you have.

[vnatale]

This is an official fact sheet from the IRS which several of the articles used as the basis for what they wrote:


https://www.irs.gov/pub/irs-news/fs-08- ... ration.%22

[vnatale]

Another view:

https://www.nolo.com/legal-encyclopedia ... issue.html


But still nothing specific for company pension / Defined Benefit plans.

[vnatale]

Guiding accountants on offering advice to clients regarding this matter:

https://www.journalofaccountancy.com/is ... udits.html

[vnatale]

Though an older article this one has some unique aspects to it compared to all the others:

https://www.thetaxadviser.com/issues/20 ... wners.html

[vnatale]

After now having scanned many articles this one is highly informative:

https://wcginc.com/business-services/s-corp-salary/

[vnatale]

This same group looks like they have done extensive homework on the subject, having written a book on all things Sub S:

https://wcginc.com/business-services/book/

[Nate79]

My reading is that defined contribution doesn't count when determining reasonable compensation that is paid by w2. I could be wrong.

[vnatale]

I'm stopping here. If I were you I'd send to them your simple question.

If it is a simple answer then they should be able to simply answer it with no charge to you.

You could tell them it's a trial to see if you want to engage their services in the future on a semi-regular basis for any future Sub-S tax issues you may need answers to.

[nplusone]

The defined benefit plan is a retirement plan established by the company for the benfit of its employees.
If the mandatory contributions are high, then there is very little money left for salary/distribution.

This is similar to pre-Obamacare days.
Imagine that the S Corp established a health insurance plan for its 2 employees.
And next year, one employee was diagnosed with cancer and needed ICU 24x7. The insurance company paid out hundreds of thousands and hence immediately jacked up the health premium to insane levels.
The S Corp still has to pay those premiums and there is very little money left for salary/distributions.

Your health insurance analogy fails in multiple ways but you don’t seem open to the input being provided. BTW any Jobs, Gates, Musk Buffet or similar comps also fail simply because they are C corps.


Will try again in a different way… paying out 10% of corp net as salary it is probably not going to fly with IRS. But if you are a CPA I am surprised you don’t know all of this.

You are right - my Jobs/Buffett analogy is incorrect because they are C corps. I have edited my earlier post.
If possible, could you elaborte the flaw in my Health Insurance analogy?

[nplusone]

I'm stopping here. If I were you I'd send to them your simple question.

If it is a simple answer then they should be able to simply answer it with no charge to you.

You could tell them it's a trial to see if you want to engage their services in the future on a semi-regular basis for any future Sub-S tax issues you may need answers to.

Thanks you vnatale for a lot of info. Still going thru it.
Trying to find info about reasonable salary with defined benefit plan.
No luck yet but one link does say
https://wcginc.com/business-services/s-corp-salary/

it is an easy analysis. Line 7 versus Line 21 of the S Corp tax return (Form 1120S). They can also look at the K-1, Box 1 (ordinary income) and compare this to Box 16, Code D (distributions).
This is not a definitive answer but if the above is indeed true, then "lower salary" wins a point. My line 7 and line 12 are in line. And K1Box1/16 are quite reasonable.

[LotsaGray]

The defined benefit plan is a retirement plan established by the company for the benfit of its employees.
If the mandatory contributions are high, then there is very little money left for salary/distribution.

This is similar to pre-Obamacare days.
Imagine that the S Corp established a health insurance plan for its 2 employees.
And next year, one employee was diagnosed with cancer and needed ICU 24x7. The insurance company paid out hundreds of thousands and hence immediately jacked up the health premium to insane levels.
The S Corp still has to pay those premiums and there is very little money left for salary/distributions.

Your health insurance analogy fails in multiple ways but you don’t seem open to the input being provided. BTW any Jobs, Gates, Musk Buffet or similar comps also fail simply because they are C corps.


Will try again in a different way… paying out 10% of corp net as salary it is probably not going to fly with IRS. But if you are a CPA I am surprised you don’t know all of this.

You are right - my Jobs/Buffett analogy is incorrect because they are C corps. I have edited my earlier post.
If possible, could you elaborte the flaw in my Health Insurance analogy?

First that simply is not how medical insurance worked pre ACA so the described situation would not occur. Thus the question is it ok by IRS simply has no meaning.

Second, even were the scenario occur as you described, you are paying a third party for a service. The provider is setting a market rate and you are choosing to buy at that price. In you case you are self dealing and setting a “price” which you solely control and has no market basis.

Third in the insurance scenario you would be buying a service. You are not directly benefitting from the premium paid. That money goes to the insurance company. They pay the doctor, et al, and you relieve the treatment. In the DB scenario you are simply passing the money to yourself. Someone else may administer the plan or be a custodian. They may take a fee cut but most of the money simply goes to you. You are paying yourself.

The DB is very apparently simply a means to pass money to yourself. At best all of the “cost” would be taxable but not SE tax but most likely IRS would see through the disguise and apply penalties while treating this indirect compensation as wages including FICA.

You ignored the easiest, simple test I proposed. Assuming your biz is a CPA firm, can you reasonably and honest claim you could hire a CPA with similar experience for the $25K wages?

Another common way to look at reasonable wages is to pay yourself at least 40% of the SCorp net. That is what many recommend as reasonable. Though I am not aware of IRS ever confirming. Certainly better chance than 10%ish you are doing.

[Rex66]

What salary are u using for your DB package. You can’t be giving yourself a lower salary then that

[nplusone]

The defined benefit plan is a retirement plan established by the company for the benfit of its employees.
If the mandatory contributions are high, then there is very little money left for salary/distribution.

This is similar to pre-Obamacare days.
Imagine that the S Corp established a health insurance plan for its 2 employees.
And next year, one employee was diagnosed with cancer and needed ICU 24x7. The insurance company paid out hundreds of thousands and hence immediately jacked up the health premium to insane levels.
The S Corp still has to pay those premiums and there is very little money left for salary/distributions.

Your health insurance analogy fails in multiple ways but you don’t seem open to the input being provided. BTW any Jobs, Gates, Musk Buffet or similar comps also fail simply because they are C corps.


Will try again in a different way… paying out 10% of corp net as salary it is probably not going to fly with IRS. But if you are a CPA I am surprised you don’t know all of this.

You are right - my Jobs/Buffett analogy is incorrect because they are C corps. I have edited my earlier post.
If possible, could you elaborte the flaw in my Health Insurance analogy?

First that simply is not how medical insurance worked pre ACA so the described situation would not occur. Thus the question is it ok by IRS simply has no meaning.

Second, even were the scenario occur as you described, you are paying a third party for a service. The provider is setting a market rate and you are choosing to buy at that price. In you case you are self dealing and setting a “price” which you solely control and has no market basis.

Third in the insurance scenario you would be buying a service. You are not directly benefitting from the premium paid. That money goes to the insurance company. They pay the doctor, et al, and you relieve the treatment. In the DB scenario you are simply passing the money to yourself. Someone else may administer the plan or be a custodian. They may take a fee cut but most of the money simply goes to you. You are paying yourself.

The DB is very apparently simply a means to pass money to yourself. At best all of the “cost” would be taxable but not SE tax but most likely IRS would see through the disguise and apply penalties while treating this indirect compensation as wages including FICA.

You ignored the easiest, simple test I proposed. Assuming your biz is a CPA firm, can you reasonably and honest claim you could hire a CPA with similar experience for the $25K wages?

Another common way to look at reasonable wages is to pay yourself at least 40% of the SCorp net. That is what many recommend as reasonable. Though I am not aware of IRS ever confirming. Certainly better chance than 10%ish you are doing.

Lotsogray, thank you for taking the time to respond. I have edited my post above to reflect that my analogy was incorrect (again).
However, I disagree on two points.
1) I believe a CPA may choose to work for $25k/year if I also contribute $180k per year in today's dollars to his pension. This is especially true, if he does not need the money right now anyways.
2) According to this very informative link provided by vnatale, the "S Corp net" is calculated by adding compensation of officers (line 7) to the line 21 (Ordinary business income).
Since my line 7 as well as line 21 are 30k, I am paying 50% of net as wages.

Am I calculating this correctly?