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Ask HN: Sources to determine "reasonable compensation?" for web CEO's

13 points by clintavo ↗ HN
I started a web company about 8 years ago, on the side. Three years ago I went full-time and have been fortunate that it is now providing me with a good income.

My CPA and Lawyer have recommended that I incorporate (I've been operating until now as a sole-proprietor), which I am in the process of finalizing.

After incorporating, I must, under IRS rules, pay myself a salary of "reasonable" and comparable compensation. For tax reasons, I want this salary to be as low as possible, but can't go lower than what would be normal and reasonable for a CEO/Software Developer of a profitable but small (under $1 million in revenues) web company.

Does anyone have any source or advice on how to come up with a reasonable number?

26 comments

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Mystalic
Reasonable to the IRS just means you aren't giving yourself a $300 salary and saying that's payment. Calculate general cost of living and use that number. You can justify that number to the IRS.
jhancock
agreed. Jobs, etc. can afford to defend their position of $1 a year. You cannot. It doesn't have to be a high number as base salary. It is very reasonable to pay yourself dividends in quarter or annual bonus (your still taxed on this but can be a bit better). The max social security cutoff is around $102k these days? Not a bad high mark. Assuming your living cost is under $60k, you can probably justify $75k and not lose any sleep. Those are rough guesses, you'll have to find your own comfort levels.

Don't try to dodge the taxman unless you can afford it. In the mid-90s, I had the IRS come after me. Turned out to be a computer error on their part, but that didn't keep them from shutting off all my bank accounts without notice. They turned back on my accounts within a week or so but I spent around $5k and 6 months to a top accountant to prove to the IRS that they were wrong. I even ended up with an apology letter from the IRS. It wasn't a form letter either, I doubt they a form for an apology ;). These buys are tough man, don't mess with the revenue service!!

brentb
I would highly recommend against just paying yourself just cost-of-living. A low salary and high dividend is a big-time audit flag for the IRS... if your salary AND your dividends are low, then there's no problem.

You state that your company is profitable. In this case, if you pay yourself a low salary and get audited, the IRS can (and will) retroactively adjust your salary to whatever THEY feel is reasonable and comparable for a CEO of a successful small company. Then you will owe back taxes, penalties and interest on whatever amount they determine you cheated them out of. The process isn't very democratic and getting audited is a HUGE pain, so I'd recommend going with something reasonable in the 100K range to avoid scrutiny.

wmorein
Do you really have to pay yourself "reasonable" compensation? I don't doubt that you were told that, but it is interesting that multiple CEOs of large, public companies (e.g. Brin/Schmidt/Page at Google, Jobs at Apple) pay themselves $1 per year.

See proxy statements at http://edgarest.com/company/name/1288776/Google_Inc_ and http://edgarest.com/company/name/320193/APPLE_INC for reference.

prospero
That's because those companies are large and public, and the equity they have in the company makes an annual salary unnecessary.

I don't see how that applies in this situation.

wmorein
In Jobs's specific case, for a while he held no equity and also drew no salary.
gcheong
I think the difference is the fact that these are public companies where CEO compensation is mainly in the form of stock grants or options. My guess is that the IRS doesn't want people claiming $1 salaries and then writing off a bunch of "business" expenses like family trips to Hawaii or stuff like that.
rcoder
The names you listed read like the definition of "outlier". If you paid attention only to the salaries that are often mentioned in the press, you would probably see these four, and a handful of those infamous Fortune 500 CEOs who see compensation on the order $30+ million.

Taking an average from that sample, I guess you'd want to pay yourself $15,000,000.50.

tptacek
You can't start an S-Corp and distro out all your compensation instead of paying payroll taxes on it. You can pay yourself $1 a year if you want to, but that needs to be all you pay yourself, or you're evading taxes.

(I'm in the same boat as this poster, but I think the S-Corp salary vs. distro thing is a big scam).

fnazeeri
According to this (http://www.altgate.com/blog/2008/10/2008-startup-compensatio...) 10-year old survey executive compensation of 600+ venture-backed startups, a founding CEO of a software company with <$5MM in revenue is in the $160-230K range (25th %ile and 75th %ile respectively). As an aside, equity is in the 8-30% range (same percentiles).

This isn't terribly helpful to you question since it's for venture-backed companies, but it's at least an upper threshold.

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clintavo
Thanks, fnazeeri, this study actually is helpful and does provide some useful data, I think it will be very helpful to have a professionally done compensation study if necessary to show the tax man.
tptacek
There are two extreme data points you're getting here:

(1) The absolute lowest number people think you could get away with.

(2) The ridiculous numbers awarded to vanity CEOs of VC-funded companies.

You probably want to be somewhere in the middle. There's no rule about what a "CEO" makes; you're compensated based on the value you create in the company. If you do the same work as a lead developer, pay yourself like a bare-bones startup would pay a lead developer.

Web companies pay CEOs 200k because they're suckers.

amobilebiz
Disclaimer: I am not an accountant or attorney so take this how you will.

My understanding of the law from our accountants and attorneys is that you do not have to pay yourself anything if you don't want to. BUT...if you do decide to pay yourself, the salary must be "reasonable and comparable" to salaries of persons with similar job descriptions and titles. In other words, if your company takes in $1M in revenues a year and you pay yourself a $500K salary it may raise a red-flag. On the other hand, if you pay yourself $1 it may also raise a red-flag. My advice is to pay yourself what you feel you are worth and the company can afford to pay you, but don't be greedy. You can always give yourself an end-of-year bonus. The point of the law is to keep you from operating the company for a profit, writing off all your expenses as business expenses and claiming on your personal taxes that you did not earn an income while the company cut you checks out of the "owner draw" account. Depending on size and revenues of your company you can always claim an S-Corp exemption and just flow through the profits/losses to your personal taxes thus alleviating a lot of this for you.

Again, I am not an attorney or accountant so I would definitely double check everything.

pelle
It sounds like you are incorporating an S-Corp. There aren't really any IRS rules like that for C-Corps, which is why Steve Jobs can get paid $1 pa.

The rule is essentially there to make sure that you pay FICA. The limit for paying FICA in 2008 is $10,200. So that should be a safe reasonable compensation. Anything you pay yourself on top of this should be done as an S-Corp distribution.

That said you could probably get away with paying less. But really your CPA should be able to guide you on this. You may be able to get away with $50k pa.

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tptacek
You missed a zero there, right? $102,000. $50k sounds sane, presuming you don't distro yourself $100k on top of it.
pelle
You are right I missed a zero.
mdasen
I think that $75k would be reasonable. That's on the low side (25th percentile), but reasonable. Below $50k and I'd say you're begging to be audited. But I don't do this for a living or anything.

Really, your CPA and lawyer should be able to give you an exact figure. That's their business. It's a little odd to ask for that advice here when you are already paying professionals in the field for that advice. Your CPA/lawyer should have experience with what is safe. Use it.

vaksel
isn't the "reasonable" compensation more about the max you can pay yourself, not the min? So that you can't set your salary at whatever your profit is, in order to avoid paying business taxes.
trevelyan
Don't incorporate in the United States? Does the law still apply?
clintavo
Thanks for all the feedback. OK further clarification: I am incorporating as an S-Corp. Income taxes on S-corps flow through to the tax returns of the owners. No taxes are paid at the corporate level.

The IRS doesn't care about the $1 salaries of public CEOs (yes I know apostrophe S isn't plural, it was a typo) because those are C-Corps. C Corps DO pay taxes at the corporate level so the IRS doesn't care what your compensation is on a C-Corp - they've already collected taxes.

I'm sorry I wasn't clear in my first post, I was NOT thinking of a $1 salary or anything like that to avoid taxes. I'm thinking in the $75K - $150K range but that's just a gut feeling that I'm looking to confirm with some kind of data source in case I have to justify it to IRS. My CPA is helpful, but he can't give me a total answer because he's not in the internet/web business...I am, hence the reason I posed the question on Hacker News.

I do however want to minimize my salary to a REASONABLE level as I don't want to overpay FICA (which caps out at 102K, but several CPAs I've spoken with feel Obama will eliminate that cap), plus I don't want to pay Medicare (3.9%) on ALL of the income the corporation generates - only on the portion reasonably attributable to my salary.

I was hoping some of the early stage YC companies or other CEOS/Developers who frequent Hacker News would have some guidance and/or a source for some general ranges of salaries for CEOs of web companies.

Thanks again for all your help.

sokoloff
As a matter of practicality, any number in the $80K+ range will be fine, though you may feel better about paying yourself $100K given that the spread in taxes is under $1K/year (from 80->100). You can go below "normal"; you just can't go below "reasonable". I'd also set the comparable position as "web developer", not "CEO", as you can make a strong case that your primary function day-to-day is more akin to web-dev than to captain-of-industry.

Another important thing to keep in mind, depending on your forecast need for credit: you may find it easier to qualify for a mortgage, to refinance, etc, if you have a higher base salary. Any amount by which you can get more favorable terms on a mortgage will likely BURY that $1K/yr in taxes. Sure you can substantiate with 2 years of tax returns, etc, etc, but that's going to invite human scrutiny, and in the current credit situation, I'd want to have the skids as greased as possible to have my application "look normal".

delano
Shouldn't you be asking your CPA and your lawyer what "reasonable" means in this case?