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Compensation Study FAQs

• Who should obtain a compensation study?

  The Compensation Study is for owners of an LLC or a C-Corporation who have made the election to be taxed as an S-Corporation.

  S-Corporations are subject to the “reasonable compensation” requirement imposed by the IRS. Yet there is very little guidance regarding what “reasonable compensation” is and the result is that most business owners overpay in payroll taxes (social security and Medicare taxes) by thousands of dollars.

  For more information about the “Reasonable Compensation” requirement, you can check out our trainings on this topic in our Resources section at www.MakeTaxesFair.com

• What do I get when I purchase a compensation study from Make Taxes Fair?

  We are proud to offer this unique service. To our knowledge, very few firms offer such a streamlined approach to aiding business owners in obtaining a Reasonable Compensation Study.

  When you purchase a Compensation Study from MakeTaxesFair.com you receive:

  • The document produced as a result of the survey that you can include with your records
  • One half hour meeting with a tax strategist to review the results of your compensation study
  • One revision (if required) as a result of that meeting

  The importance of a Compensation Study is that this helps you to rebalance compensation to accurately reflect the role and responsibilities that you assume in your business and generally rebalances the W-2 compensation to ultimately pay less in payroll taxes.

  This is critical to protecting your S-Corporation in the event of an audit.

• I need to perform an audit of my time? For what reason?

  This means that you sit down and evaluate what roles you spend your time in an average week.

  This is critical because we need to understand what “higher value” roles and “lower value” roles you perform for your business.

  Examples of higher-value roles: Strategic planning Business operations (“C” suite level) Sales and sales manager roles

  Examples of lower-value roles: Janitorial Clerical Bookkeeping

   

  When we say “higher value” and “lower value” we don’t mean that these roles are not important or necessary. We mean that those roles, if outsourced to someone else, would cost more or less in terms of value for time or an hourly rate.

  When we understand what roles you are filling and how much of a standard 40 hour work week you are spending in that role, we can craft what the reasonable amount of compensation should be for you.

• What if I have multiple businesses? Do I need a time audit and compensation study for each business?

  The short answer is YES. And the reason for that answer is best given by providing an example. 

  Our client Jim has 4 businesses.

  Biz #	Niche	Description	Legal Structure
  Biz #1	HVAC Company	HVAC installation, service and repair.	C-Corp taxed as S-Corp
  Biz #2	Home Inspection Company	Home inspection services company	LLC taxed as S-Corp
  Biz #3	Operations Consulting Company	Business systems and operations consulting	Schedule C/Sole Proprietor
  Biz #4	Real Estate Rental Properties	Real estate rental portfolio	LLC not taxed as S-Corp

   

  Business numbers 1 and 2 are the only ones that require a reasonable compensation study because they are the ones that have made the S-Corporation election. The Sole Proprietor/Schedule C and the LLC that is NOT taxed as an S-Corporation do not (and should not) pay Jim as a W-2 employee.

  For business #1, the HVAC company, Jim’s role is that of a CEO. However, it’s a smaller company (15 employees total) and while he operates as the CEO in name, he truely is more of a “owner-operator”. Jim is directly involved in all aspects of the business from hiring and training employees, to going out on service calls and handling client interactions himself.

  For business #2, the Home Inspection Company, Jim’s role is less involved as he has a General Manager that is paid handsomely for her role. She is effectively the business operator of the Home Inspection Company and Jim’s involvement is minimal (6-8 hours a week) at best. He primarily interacts with his General Manager and has very little contact with the employees of that company. In this sense, he really is operating in more of a CEO role rather than that of a business operator.

  Understanding the company structure and your level of involvement is critical because the role that you fill does matter. CEO’s typically come with a much higher price tag in the business world and it’s not uncommon for CEO compensation to range in the low $100,000 to $450,000+ for smaller companies. 

  But when a business owner is filling the role of a CEO but with more direct involvement and acting more as a “operator” of the business, then it’s reasonable to allocate less time and effort that is spent in that true CEO role and allocate more time to the other roles.

  In Jim’s case, there is a clear distinction in what would be considered reasonable pay or compensation for a service technician performing a service call to a client's HVAC versus the compensation for a CEO participating in meetings and strategic planning for the company.

  In Jim’s case, allocating what time is spent in those two roles will aid in balancing the compensation that should be paid from each company to remain compliant with the IRS S-Corporation “reasonable compensation” requirement.

  As such, because these are two different companies with Jim serving in two very different roles, he would need two different compensation studies (one for each company and role) to protect himself in the event of an audit.

• What if I’m an LLC that has NOT made the S-Corp election yet?

  Only entities that have made the election to be taxed as an S-Corporation are required to pay a reasonable compensation amount to the owners.

  If you are an LLC that has NOT made the election to be taxed as an S-Corporation, then this is not a requirement.

  In fact, owners of LLC’s should NOT pay themselves through W-2 wages but rather should take ownership draws or what are sometimes called Guaranteed Payments to a partner.

  To learn more about that topic, please refer to the Resource section at www.MakeTaxesFair.com for our training on LLC’s.

• What does a “time audit” look like and how do I do this?

  When we create a compensation study report, we use the standard 40-hour work week as the base. The areas of your time that we need you to evaluate are 

  Maintenance

  • Janitorial
  • Maintenance & repairs
  • Grounds maintenance

  Administrative

  • Office Clerk
  • Secretary or Administrative Assist
  • Receptionist
  • Correspondence Clerk
  • Customer Service Representative
  • File Clerk

  Marketing

  • Market Research Analyst
  • Sales Representative
  • Sales Representative- Technical
  • Retail Salesperson
  • Cashier
  • Order Clerk

  Finance

  • Bookkeeper
  • Payroll Clerk
  • Billing & Invoice Clerk
  • Collections Clerk
  • Budget Analyst
  • Accountant

  Human Resources

  • Human Resources Clerk
  • Employee Training & Development
  • Human Resources Generalist

  Information Technology

  • Computer User Support Specialist
  • Network Technician
  • Database Administrator

  Inventory

  • Shipping & Receiving Clerk
  • Purchasing Clerk
  • Purchasing Agent
  • Wholesale & Retail Buyer

  Management

  • Chief Executive
  • General & Operations Manager
  • Business Office Manager
  • Sales Manager
  • Advertising & Promotions Manager
  • Supervisor of Administrative & Clerical Workers
  • Supervisor of Non-Retail Sales Workers
  • Supervisor of Retail Sales Workers

  When you conduct an audit of your time in relation to these areas you are simply determining where you spend your time in which of those areas of business and functions within the business.

  As an example, a Commercial Landscaping company owner/operator may spend time in the category of Maintenance of equipment for 2-3 hours a week where the owner operator of a Marketing Agency would not spend time in that category because there is no equipment to maintain.

  No two businesses are exactly the same and no two owners will allocate their time the exact same way.

  Having a broad knowledge of the various areas that we examine when looking at how you spend your time is critical to understanding what is required in the request for an audit of your time.

• I wish I only worked 40 hours a week! How do I do a time study if I work more than the 40 hours a week allotment you are asking for?

  When we create a compensation study report we use the standard 40 hour work week as the base.

  Many business owners work well over 40 hours a week we understand but using the baseline 40 hours a week gives us a starting point and helps us to assign an hourly wage to each area of responsibility that you perform.

  Step 1 is to audit your time on a weekly basis based on what hours you actually work on average. If you have a seasonal business where things slow down for part of the year and you end up working 20-30 hours a week but then in your busier times you are working 60-70 hours a week then it’s recommended that you use your busier time as the baseline.

  Step 2 is to then take your total time by task and determine what percentage of your total time worked in that week that is spent on that task.

  For example:

  Tom works a 67 hour work week on average and on average his time is spent as such:

  Role	Hrs Worked	% of Total Time
  Clerical	10	14.93%
  Sales- front line	30	44.78%
  Sales- manager	15	22.39%
  Accounting/bookkeeping	5	7.46%
  HR- Training	5	7.46%
  Janitorial	2	2.99%
  Total hours/%	67	100%

   

  The audit of his time and understanding the hours spent in each role as part of the total hours worked allows us to apply the appropriate % of time spent in each role to the 40 hour a week standard.

  Step 3 is that we take that 40 hour a week standard and increase or decrease accordingly based on the actual hours worked using the hourly rate as such:

  Role	Hrs Worked	% of Total Time	Hourly Rate	Weekly Wage
  Clerical	10	14.93%	$19.57	$195.70
  Sales- front line	30	44.78%	$36.42	$1,092.60
  Sales- manager	15	22.39%	$55.98	$839.70
  Accounting/bookkeeping	5	7.46%	$25.19	$125.95
  HR- Training	5	7.46%	$31.14	$155.70
  Janitorial	2	2.99%	$17.00	$34.00
  Total hours/%	67	100%	-	$2,443.65

   

  In this instance, the wage that Tom had been paying himself on a weekly basis was $3,350 for the week or $13,400 for the month and an annual salary of $160,800.

  With a compensation study performed, his W-2 wages dropped to $117,295.20 and was based on his actual work performed in the various roles he filled.

  Properly aligning his W-2 wages resulted in more than $5,000 in annual payroll tax savings. That’s $5,000 in tax savings achieved from a small investment of time and resources it took to obtain a compensation study.

  When I asked Tom how long it took him to pull all the information together for the compensation study to be done, he said it took him about an hour to complete his time audit and our total time interacting with him was about an hour total. So, Tom realized a $2,500 per hour rate of return for his time to investigate and invest in a compensation study!

  Removing the guesswork from what compensation should be and applying the method of conducting a compensation study is critical and can yield thousands of dollars in tax savings!

• What other information do you need from me to create this reasonable compensation study?

  Aside from the time audit (that is 100% required), we also need to know:

  Your first name

  Your last name

  *The business name for which we are performing a compensation study

  The business description 
  For this, we use your business description to determine what the NAICS Classification for your business is. The NAICS refers to the North American Industry Classification System which is the standard used by the IRS and other government agencies to determine what type and nature of business you are.

  A detailed description of your role, title, and responsibilities

  In the other FAQs below there are examples provided of why this element is so key and how it pertains to determining what reasonable compensation should be for you. We invite and encourage you to quickly review the full set of FAQ’s in this section.

  The legal and tax structure of the business (ex: LLC taxed as an S-Corporation, or a C-Corporation taxed as an S-Corporation)

  State you live and work in

  City you live and work in

  County you live and work in

  Regarding the State, City, & County you live in, we are interested in where you live and are based. If you travel for work, we are using your home base as a basis for what your salary is.

  For example: A New York City resident may likely have a higher base pay than a resident in a small town in rural North Dakota simply due to the cost of living differences. These factors are considered when determining compensation and your State, City, and County of residence can have a significant impact in determining the right number.

  What your current W-2 salary that you pay yourself is (if applicable)

  A brief explanation of how you arrived at this W-2 salary amount

  Briefly describe how you arrived at the figure you currently pay yourself as a W-2 wage. This is helpful to know and understand what methodology is being used to arrive at your current system that is being implemented.

  * Please note, if you have more than 1 business for which you need to determine the reasonable compensation for, then we need to perform a SEPARATE study for that business. That requires a separate set of inputs including time audit, etc. There will be an additional cost for this and any additional compensation studies.

• When you say that you need a description of my business and my role, title, and responsibilities, what do you mean?

  Referencing the example of Jim in the FAQ above and his 4 companies, it’s critical to understand what your business is and responsibilities to that business are.

  An example of a comparison of two different people and how compensation can vary is the case of Todd and Sam. Both Todd and Sam are dentists and their case sticks out as they shared an office space to reduce the cost of overhead but they had their own independent practices.

  Todd practiced general dentistry and did not specialize in any specific area.

  Sam specialized in sedation dentistry where his patients receive deep sedation or general anesthesia.

  In evaluating these two dentists, their compensation was widely different as Sam was more specialized and his practice required additional licensing and certification.

  Another case is that of Adam and Jack.

  Adam was a roofing contractor who handled roofing and also took on jobs like siding and gutters while Jack was a contractor who exclusively handled gutters.

  Adam’s compensation study ended up splitting his time between not only the administrative and operational work of running a company but also allocated time to the time he spent actually working on roofing jobs, gutter jobs, and siding jobs. Each of those responsibilities required different skills and came attached with a different pay scale.

  Jack’s compensation was significantly easier to determine as his time was allocated more easily.

  In all of these examples, each of the business owners was not paying themselves an appropriate amount of W-2 compensation which resulted in their overpayment of payroll taxes by a significant amount (thousands of dollars in each case).

  Having a firm grasp on what your business does, what your role in the business is, and how you spend your time is critical to determining the right amount of compensation for you and helping you to avoid overpayment of payroll taxes for yourself.

• What if I am paying myself LESS THAN what the Reasonable Compensation Study report results say that I should be paying myself?

  This is a great question and one that we address in our training on Reasonable Compensation found in our Resource center at www.MakeTaxesFair.com

  In that training, we reference an attorney who was paying himself a mere $30,000 a year.

  He was the sole owner of his firm and his S-Corporation was netting over $500,000 annually in profits. It is not reasonable that in any reality that an attorney working the kind of hours that he worked be paid only $30,000 a year as a W-2 salary.

  In his case, his compensation was adjusted to reflect a more competitive wage of $215,000 based on the Cost Approach as his time was spent doing higher value attorney work combined with lower cost/value time spent on administrative type tasks as well as sales and marketing tasks.

  Adjusting his compensation provided an opportunity to not only protect his S-Corp status if he were to be questioned but also opened the door to increase retirement benefit contributions.

  The negative impact of the additional payroll taxes incurred were more or less washed out by the ability he now had to contribute more to his retirement to create a confident financial future.