One by product of all the recent government programs is a renewed discussion of this concept of “Fair Market Wage”. After reviewing hundreds of financials, a common theme for S-corp owners is to underpay themselves and take the remainder of their living expense via distributions.
I get it! Payroll taxes can add up—OASDI totals 12.4% between employer and employee, and 2.9% for Medicare for a grand extra tax total of 15.3%. That’s real money. But let me offer 5 alternate reasons of why practice owners should take the extra hit and pay themselves a real market wage:
1- Audit Risk: While the risk is pretty low of any given return getting audited (see your chances of being audited HERE), when it happens, the IRS does not mess around. I’ve helped clients gather documentation, to include years-old statements and check copies, and it sticks out as one of the more painful things a client can go through. The IRS is out to win, and underpaying yourself through an S-Corp is a really easy way to lose that battle.
2- Social Security: in my almost 15 years as an advisor, I have only seen one client not take social security because they did not need it. The going sentiment is that if you paid into the system, get every penny you can out! While social security income is not particularly substantial, it does help with retirement forecasts, and guess what? It’s based on W2 wages. So if you’re paying yourself $30,000, you’ll get the retirement benefit of someone who was a career grocery store employee. The max benefit available in 2020 is based on wages of $137,700 to give you an idea of how the system works.
For younger docs, it's a real possibility social security will look different in your future. However, unless we move toward a much more radial approach, a new structure would most likely still be earnings based.
3- Profit Sharing: Practices with 401(k)s and Simple IRAs, this is for you. Your company match for retirement plans is based on % of income, and your practice’s ability to match is also based on income. The more you pay yourself, the more you can defer- and match. This becomes even more important with the profit-sharing portion of a 401k plan, where most contributions skewed based on income. The more you pay yourself, the more contributions tilt toward you.
4- Budgeting: Getting regular W2 income is a really simple budgeting technique—you live off of what comes into your bank account. While practically speaking this works best for practices that gross (pre owner wages and distributions) less than ~$500,000, it still can serve as a budgeting “bucket” to higher earning practices.
5- Government Aid: It’s likely everyone reading this accepted PPP funds. And it shouldn’t be a surprise to note when you read the CARES act legislation, it took care to make sure participants were following IRS rules. (For example, stimulus checks were tracked by tax return filings and the EIDL loan is worded to prevent excess bonuses and distributions). Hopefully we won’t need more stimulus for a long while after Covid has passed, but if we do, I suspect paying yourself what you’re a fair market wage will continue to matter.
While paying an extra 15.4 % in payroll wages isn’t attractive, there are lot of carrots (and a big audit stick!) for s-corp owners to pay themselves a fair market wage. A starting point to determine what fair market wage might be for you is $30,000 per day of patient care + some amount for administration, production based, or matching what you pay associates in your office + administration. Talk with your CPA and advisors about what would work best for your situation, and it's not a bad idea to outline your wages, roles and responsibilities in writing to document fair market wages.
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