A proper compensation structure is necessary. The IRS uses a standard of “reasonable compensation” for determining whether a business owner is paying themselves a proper salary. The IRS is concerned that taxpayer’s would consider giving themselves a intentionally deflated salary. This deflated salary results in the owner paying less money into Social Security and Medicare (FICA tax).
It is important to work with a professional that understands your industry and can assist in determining what a “reasonable” salary would be. Each situation can be different. Key factors that should be looked at are number of professional staff, other profit centers, and the number of hours the business actually spends providing services as opposed to running the office.
The business owners desire to save needs to be considered as well. If the business has a defined contribution plan such as a SEP, a profit share plan or a Money Purchase Pension Plan, then a lower salary could have a negative impact on the amount of money that a business owner would be able to put away for themselves. Often the tax savings from contributing to a defined contribution plan are greater than the saving related to paying less FICA tax.