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What is considered a reasonable salary in IRS eyes?

Alexey Poverinov's Profile

Hello, I started my own company last year and I was told to set up my LLC as a Sub S where I can pay myself a reasonable salary and the rest would be considered as dividends or just personal income where I don't have to pay fico taxes on it. Now I'm not exactly sure what reasonable salary is. Let's say my net profit for 2015 is $250K I was a VP in my previous job and I was getting paid around $85K. My responsibilities were a lot higher and I was working a lot more. However since I started my own business I'm doing less work that I use to do, however all the income is pretty much mine. Can I pay myself $85K as salary and $165K as company benefit/dividend? Any help or suggestion would be highly appreciated.

Answers

Mary Schaeffer
Title: Publisher & Editorial Director
Company: AP Now
(Publisher & Editorial Director, AP Now) |

I'm not a tax pro and I am sure they will have something to say but two things jump right out at me.

1. If you take more in dividends than you do in salary, you are greatly increasing your chances of an audit.

2. If you were a VP in your former job and now you own the company, I would make the case you have more responsibility (and hence deserve a higher salary). While you might have been responsible for a higher dollar volume in the past, you now have responsibility for EVERYTHING - not just a part of the action.

I do not think the IRS would think your division of salary and dividends reasonable - but am interested to see what the tax pros have to say.

Anonymous User
Title: CFO
Company: Local Government Agency
(CFO, Local Government Agency) |

From knowledge and experience:

1) The IRS has less interest in the FICA aspect. It's in their purview, but they are looking at the larger picture: FIT.

2) In a split between dividends and W-2 wages like this, they'll take the position that "reasonable salary' is whatever amount maximizes federal income tax.

I know of a case where they fought an LLC owner who paid himself a $1M annual salary because it maximized the income tax liability.

So, split it as you see fit and document how you arrived at that. And remember, the salary should be consistent year to year while the dividends should vary with profitability.

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