For real estate professionals operating under an S-Corporation (S-Corp), structuring owner compensation is a delicate balance between tax efficiency and regulatory compliance. Paying yourself correctly ensures you meet IRS requirements while maximizing the benefits of your S-Corp election. This guide explores key considerations, best practices, and diverse perspectives to help real estate S-Corp owners navigate compensation.

Why Owner Compensation Matters in an S-Corp

In an S-Corp, income flows through to shareholders, who report it on their individual tax returns. However, shareholder-employees must also receive “reasonable compensation” in the form of a salary subject to payroll taxes. Failure to meet this standard can result in penalties, increased scrutiny, or reclassification of distributions as wages.

IRS Requirements on Reasonable Compensation

The IRS requires S-Corp owners performing services for the company to pay themselves reasonable compensation before taking any profit distributions. The salary must reflect fair market value for the work performed. This ensures payroll taxes, including Social Security and Medicare, are properly withheld and remitted.

Key Components of S-Corp Owner Compensation

1. Reasonable Salary

A reasonable salary is the cornerstone of S-Corp owner compensation. To determine a fair salary:

• Benchmarking: Research industry standards for similar roles in your market and region. Websites like Glassdoor or Payscale can provide valuable insights.
• Experience and Expertise: Consider your professional qualifications, years of experience, and the value you bring to the business.
• Business Size and Revenue: Adjust your salary according to the profitability and size of your real estate operations.

2. Profit Distributions

After paying a reasonable salary, remaining profits can be distributed to shareholders as dividends. These distributions are not subject to payroll taxes, creating a tax advantage. However, excessive reliance on distributions over salary may trigger IRS scrutiny.

3. Health Insurance Premiums

S-Corp owners can include health insurance premiums paid by the company as part of their wages. This is a tax-deductible expense for the business and is reported on the owner’s W-2.

4. Retirement Contributions

Structuring compensation to include contributions to a retirement plan, such as a SEP IRA or 401(k), can enhance tax efficiency. Contributions are tax-deductible for the business and grow tax-deferred.

Avoiding Common Pitfalls

1. Setting Unrealistically Low Salaries

Some S-Corp owners attempt to minimize taxes by assigning themselves a minimal salary. The IRS scrutinizes compensation that does not align with industry norms. In a 2014 case, the IRS successfully argued that a CPA’s $24,000 salary was unreasonably low for someone running a profitable firm.

2. Ignoring Business Profitability

If the business is highly profitable, a disproportionately low salary can raise red flags. For example, an S-Corp owner reporting $500,000 in profits but only a $30,000 salary could attract an audit.

3. Misclassifying Personal Expenses

Including personal expenses, such as family vacations or luxury items, in the company’s expenses is a common mistake. The IRS disallows such deductions and may impose penalties.

4. Overlooking Tax Implications of Distributions

While distributions are not subject to payroll taxes, they are still taxable income. Proper record-keeping and timely tax payments are essential to avoid penalties.

Real Estate-Specific Considerations

For S-Corp real estate businesses, additional factors can influence compensation decisions:

1. Variable Income Streams

Real estate income, such as rental revenue, sales commissions, and property management fees, can fluctuate significantly. Structuring a flexible compensation plan that adjusts to cash flow is crucial.

2. Pass-Through Deductions

Under the Tax Cuts and Jobs Act (TCJA), S-Corp owners may qualify for a 20% Qualified Business Income (QBI) deduction. Proper compensation planning ensures you maximize this deduction while meeting IRS standards.

3. Depreciation and Expense Allocation

S-Corps often benefit from depreciation deductions on rental properties. These deductions can reduce taxable income, allowing for optimized owner compensation strategies.

Steps to Structure Compensation Effectively

1. Conduct a Salary Benchmark Analysis

Research salaries for similar roles within your industry and geographic area. Use these benchmarks to set a reasonable base salary.

2. Separate Personal and Business Finances

Maintain clear records of business income, expenses, and owner distributions. This simplifies tax reporting and ensures compliance.

3. Work with a Tax Professional

Consulting a tax advisor ensures your compensation plan meets IRS standards while maximizing benefits. A professional can also identify tax-saving opportunities specific to your real estate S-Corp.

4. Review Compensation Annually

Revisit your salary and distributions annually to reflect changes in business profitability, market conditions, or tax laws.

Statistical Insights

• IRS Enforcement: In 2020, the IRS reported identifying over $2.3 billion in underreported payroll taxes. Unreasonable compensation in S-Corps is a frequent target.
• Average Salaries: According to Payscale, the median salary for property managers in the U.S. is $50,000–$70,000 annually, depending on location.

Diverse Perspectives on Compensation

1. Risk-Tolerant Owners

Some business owners prioritize tax savings and take lower salaries, opting for higher distributions. While this reduces payroll taxes, it carries a higher audit risk.

2. Conservative Planners

Others prefer to err on the side of caution, paying themselves salaries at the higher end of industry benchmarks. This approach minimizes audit risk but may reduce immediate tax savings.

3. Growth-Oriented Owners

Real estate investors focused on scaling their businesses often reinvest profits rather than distributing them. Structuring compensation to align with growth goals can help achieve long-term success.

Conclusion

Structuring owner compensation for real estate S-Corps requires a strategic balance between compliance and tax efficiency. By setting a reasonable salary, leveraging profit distributions, and incorporating tax-advantaged benefits like health insurance and retirement contributions, you can optimize your compensation plan while meeting IRS requirements.

To navigate these complexities effectively, consider partnering with a trusted tax advisor, such as Private Tax Solutions. With expert guidance, you can maximize savings and protect your business from potential penalties.