Compensation Optimization

Compensation optimization is the process of reviewing your total “compensation” needs and determining whether changing business entities would help better distribute the compensation across various types of income. Certain entity types will have owner or shareholder compensation requirements that are dictated by the facts and circumstances of the business and what the taxpayer's personal income needs are currently.

Schedule C: Owners are generally free to take cash out of the business at their discretion without further tax consequences and are not required to pay themselves a salary via payroll.

Partnership: Partners are generally free to take distributions of their share of partnership profits without further tax consequences. Partners cannot pay themselves salaries via payroll, but they can provide for “guaranteed payments,” which are distributions that are not determined by the partnership’s income or their proportionate share.

S corporations: Distributions paid out of an S corporation are not subject to self-employment tax. As a result, Congress added the requirement that owners who work for the corporation pay themselves “reasonable compensation” via payroll, subjecting those wages to payroll taxes at both the company and individual levels.

C corporations: Dividends are not subject to self-employment or payroll taxes. However, they are also not deductible from the taxable income of the corporation. On the other hand, salaries paid to shareholder-employees are subject to payroll taxes, but they are deductible in calculating the corporation’s taxable income. C corporation owners must take a “reasonable salary” to avoid large deductions.