December is the month we revisit salary and wages paid to our CRE brokers from their LLCs. If you are paid 1099 income as a Sole Proprietor this is not an exercise for you. However, for CRE brokers who are paid 1099 income, have setup an LLC and elected S-corp tax status, this is a very important annual process.
Not all your 1099 income should have self-employment taxes or payroll taxes. Establishing a salary below your expected income will remove that difference, the flow-through profit, from Medicare taxes and possibly some payroll taxes depending on your income and wages paid. This difference shouldn’t be excessively big, and your salary shouldn’t be unreasonably low. Paying yourself a reasonable salary is necessary to avoid IRS scrutiny.
What to pay yourself is a different topic for the beginning of the year. Year-end decisions regarding wages paid come down to the Qualified Business Income tax deduction and increasing the credibility in your employee/LLC owner relationship.
The Qualified Business Income (QBI) tax deduction is a deduction from income, generally in the amount of 20% of net income or profit from a qualified business, in this case your LLC. The QBI deduction is limited to 50% of W-2 wages paid by the business.
If your business has income of $100k and you pay yourself a salary of $50k, the business will have net income of $50k. To keep this simple we are ignoring all other business expenses that would lower the net income further. The $50k of net income from the business will get a QBI deduction of $10k, which is 20% of $50k.
The QBI limitation in this example would be 50% of $50k, or $25k. If you had decided to pay yourself less than $25k, or the gross income to the business was greater than $100k then it is possible you would have hit the cap on the deduction.
For example, $200k of gross business income with $50k of wages leaves $150k of net income. The QBI deduction on $150k of net income is $30k. The QBI deduction limit would still be $25k with these wages paid. To fix this you will need to increase your wages. Taking the potential $30k QBI deduction and dividing it by 50% will give you a required salary of $60k to maximize the deduction. As the gap between business income and wages paid gets larger the more likely you are to need to make year-end adjustments to your salary.
To add more credibility to the relationship between you as employee and yourself as owner of the business, it can be a good idea to add a variable component to your salary structure. One technique is to add a December bonus that is paid based on a percentage of gross income to the business.
If your average year brings in $300k of revenue, then this bonus could be structured as 10% of revenue above $300k will be paid as bonus wages in December. For example, this year you bring in $400k of revenue then your bonus will be $10k which is 10% of the revenue above your $300k average. Adding this creates more skin in the game for you as an employee of your business and not just as the business owner.
There is still time to make year-end adjustments. Let us help you avoid common salary mistakes.
