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S Corp Salary Starting Point

Article ID: 336
Last updated: 24 Nov, 2018
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By Jason Watson ()
Posted November 23, 2018

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 the Watson CPA Group 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% (which is why CPA firms sell for about 1.1 times gross revenue… this suggests a 3-year payback period at 100% retention or about 5-6 years with the usual 60% retention… acceptable ROI).

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.

Taxpayer's Comprehensive Guide to LLCs and S Corps : 2019 Edition
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