As a Realtor you may have formed an S corporation to save on self-employment taxes.
If so, is your S corporation salary
- too low?
- too high?
- just right?
Getting the S corporation salary right is important. First, if it’s too low and you get caught by the IRS, you will not just pay income taxes and self-employment taxes on the too-low amount, but you will also both payroll and income tax penalties that are often very costly.
Second, in most cases, the IRS is going to expand the audit to cover three years and then add the income and penalties for those three years.
Third, after being found out, you likely are now stuck with this higher salary, defeating your original purpose of saving on self-employment taxes. And the snowball effect of underpaying yourself can really overtake a Real Estate Business quickly.
When it comes to determining how much you should pay yourself, getting to the number can be quite daunting, but there are 2 approaches that you can take when determining your salary.
The market approach to reasonable compensation compares your S corporation’s real estate business with other real estate businesses and then looks at the compensation being paid by those real estate businesses to employees who look like you, the shareholder-employee who is likely the Broker/Owner/Agent.
The question to be answered is, how much compensation would be paid for this same position, held by a nonowner in an arm’s-length employment relationship, at a similar company?
The IRS states that the courts favor the market approach, but because of challenges in matching employees at comparable companies, the IRS developed other approaches.
The cost approach breaks your employee activities into their components, such as real estate sales, management, accounting, finance, marketing, advertising, engineering, purchasing, janitorial, bookkeeping, clerking, etc.
Here’s an example of how the cost approach works to support a $71,019 salary as reasonable compensation for this S corporation owner whose real estate corporation had $350,000 in revenue and 2 employees:
There is really a ton to consider when determining your salary and if you do it wrong it could end up defeating the purpose of even having an S-Corporation.
This is just one example where working with the right Tax Expert can help you make better decisions for your Real Estate Business.
If you’d like to discuss this or other tax topics go ahead and schedule a call.