Is there a rule for salary I should pay from business?

Question

I own a computer software development business. The net income is around $120,000/yr.

I pay myself a salary of a flat $1,000/month ($12,000/yr) and the rest I just write a distribution check. So $12,000/yr in 'salary' and $110,000 in distribution checks.

I report 100% of my income honestly and only take valid deductions (I can't really cheat on the taxes as 100% of my customers pay with check or cc and it all hits the bank account - I don't get paid cash every that I can just burry in the backyard).

In any case I've been reading some forums online that say the IRS wants to see you pay a reasonable salary so you pay into Medicare and SS. I hate doing this because of the state paperwork and the business then has to match the Medicare and SS payments.

Is there any exact number or percentage of the business income you should pay yourself as to not raise eyebrows at the IRS? I've been paying myself like this from the business for the past 10 years. Never got any nastygrams from the IRS. I'm assuming if they wanted to be jerks they could make up a number I should have paid myself, then make me pay back taxes into SS. Is there any magic number they look for as far as salary? Is it defined by law?

paulthomascpa · Accepted Answer

wroteThe magic number is what the going rate is in your area for the work you do for your business.  So the measure would be, if you had to hire someone to do everything you do, what would you have to pay.  And that should be your wages.  It's going to fall on you to defend that amount if it comes to an audit, and they're looking at wages from "S" corporations for unreasonably low wages.

Alan · Answer

This is a highly litigated area of practice. There are many factors that are used to determine reasonableness. The most recent case of interest (the taxpayer was a CPA) is David E. Watson, P.C. v US, 107 AFTR 2d ¶2011-305 (S D IA, December 23, 2010. The court looked at 9 factors in making the determination that Mr. Watson's salary was only about a quarter of what it should have been. There is a very good summary of the case at:

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Actual text of the opinion is at:

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removeps-groups · Answer

$10,000 per year for a software developer is quite low. In the Bay Area they make between 80k and 150k, though it could be more or less.

It's still possible to cheat even if only check and credit card because you can claim meals and expenses, take a deduction for assets you buy for personal use, etc.

But you're already doing this for 10k, so it would be just as easy to do this for a larger amount. I'm wondering if you can pay yourself on a 1099-MISC, and that way the company does not have to file W-2, form

941. You just report the income on your Schedule C, but take no deductions on that form.

There is no numerical formula. Just adjectives.

Is there a rule for salary I should pay from business?

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