Fixing Compensation for 2014

As 2013 draws to a close, now is the time to plan what you’ll be paying yourself and your staff next year.

If you are self-employed, payments you take as draws have no tax implications, but if you’re an employee of your corporation, figure your salary for 2014.

Compensation paid to owner-employees as well as to staff members of any businesses impact what the business can deduct as well as what employees report as income.

Here are some issues to consider:

Reasonable compensation
Your business can only deduct what is reasonable pay for the work performed. What’s reasonable?

Think about what an independent investor would pay someone for the work being done, what competitors are paying their staff, and your business’ profitability and cash flow. Taken together, you’ll likely reach a payment amount that’s viewed as reasonable by the IRS.

Special concerns for S corporation owner-employees
Since all distributions from an S corporation are taxed to owners, there’s a tendency to take less than reasonable compensation to avoid FICA on salary, treating the balance as taxable distributions of profits exempt from FICA.

Don’t underpay because the IRS is on the lookout for this practice. There has been a lot of litigation on this point and courts frown on owner-employees who take little or no salary.

So pay reasonable compensation to owner-employees. Some tax advisors suggest keying compensation to the Social Security wage base where this would be viewed as reasonable. For 2014, the wage base is $117,000 (up from $113,700 in 2013). Ask your tax advisor whether this makes sense for your business.

Additional Medicare taxes
Wages and other taxable compensation over a set amount is subject to an additional 0.9% Medicare tax paid by the worker (not matched by the employer). The thresholds depend on filing status: $250,000 for joint filers; $200,000 for singles. These thresholds are not indexed for inflation, so they are the same in 2014 as they are for 2013.

For owners and highly-paid managers, consider other ways to give compensation without triggering this additional tax. This can include, for example, issuing stock or paying for nontaxable fringe benefits. Review the IRS fringe benefits guide.

Final thought
Meet with your company’s tax advisor to discuss compensation plans for the coming year. Obviously, what you pay is not only a matter of tax law, it also depends on what you can afford.

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