For those CRE brokers who have taken the step of forming an LLC and electing S-corp status, you have the added task of determining your salary every year. Our firm has many recommendations and strategies to help brokers determine their salary and avoid IRS scrutiny.
Due to Covid-19, revenue for 2020 may have more unknowns and therefore, a reevaluation of your salary is likely warranted. If you are expecting significantly lower revenue, we can help you analyze why you may or may not want to decrease your salary this year.
The first goal of determining your salary is to ensure it is considered reasonable compensation by IRS standards. The term “reasonable” is a gray area but generally it should not be significantly lower than your revenue. It is tempting to save on payroll taxes but setting your salary above the Social Security wage base of $137,700 (for 2020) likely takes the pressure off from the IRS. But before changing it, you need to recognize how this can impact your retirement account contributions.
We suggest using a 401(k) over a SEP IRA. If your goal is to maximize your 401(k) contribution this year, then you are relying on employer profit sharing to top off the contribution. This year you can contribute a total of $57,000 to a 401(k) through an employee deferral (contribution) of $19,500 and an employer profit-sharing contribution of $37,500. You can contribute an additional $6,500 if you are age 50 or older. The profit-sharing contribution is based on 25% of your wages, so a salary of $150,000 will give you the full profit-sharing contribution of $37,500.
Another retirement account we typically recommend for brokers who are older and wish to maximize their 401(k) contributions is a Defined Benefit Plan (DBP), also known as a Cash Balance Plan. The contributions going into these accounts are based on several factors including average salary over a period of time. If your goal is to maximize the DBP contribution, then you will likely need to keep your salary at or above $285,000. There are many other factors and strategies which go into DBP contributions, but today’s discussion focuses on salary.
If your revenue has dropped enough to minimize or eliminate these goals, then a salary lower than $150,000 may be justified. You should keep salary in the range of one-third to one-half of top line revenue. Delaying this analysis and decision is also an option, as you do not need to continue last year’s salary. It may be advisable to pause until the 4th quarter to see how revenue has been affected and determine the salary at that point.
Determining your salary should be an annual exercise. If you wish to weigh your options with a trusted partner, let us help evaluate the best strategy for you.
