The benefits and pitfalls of zeroing-out owner?s comp

Should an owner ever take a $0 salary to make ends meet? When does it make sense?

October 13, 2010

Should an owner ever take a $0 salary to make ends meet? When does it make sense?
—Full-service remodeler, California

Eliminating your salary as company owner is a valid tactic if it will help keep the company afloat when little money is coming in. Be careful, though. Make certain that it is legal for the kind of corporation you have. And never skip your salary to avoid taxes.
While you may choose to sacrifice wages in an honest effort to keep your company alive, zero pay for business owners has a bad reputation due to years of abuse by tax evaders.
“It’s a very litigated area,” says attorney and author Barbara Weltman, principal of Big Ideas for Small Business, Millwood, N.Y. For the IRS, it can raise a red flag.

What’s Allowed
Your accountant and your lawyer can determine if you are legally permitted to pay yourself nothing. Weltman provides this quick summary of the rules, based on four corporate structures.
LLC or General Partnership: As owner of a limited liability company or partnership you are not an employee and don’t get a salary, but may take a “draw.” You can take out zero, using the income instead to help pay the company’s bills. Keep in mind that you still will owe—and should pay in a timely fashion—taxes on your share of the business’s total income. That includes self-employment tax.
S Corporation: Because only the salary portion of their business income is subject to FICA, some S corporation owners trim their wages to evade taxes. Bad idea. The IRS and the courts have cracked down, saying you must receive a “reasonable” salary for the work you perform. What is reasonable? It’s what you would have to pay somebody else to do your job. In a down economy, that might be a very low salary. But it probably won’t be zero.
“The IRS will be looking closely if you claim no salary,” says Weltman. “It’s probably best to take some minimal pay if you can.”
C Corporation:  Owners of C corporations generally take the largest salary they reasonably can in order to minimize corporate income and thus keep corporate taxes low. However, if your cash flow is poor and you need to take little or no pay, as a C corporation owner you can.
Sole Proprietor: The income for a sole proprietorship can be distributed as you wish—into your pocket or not. You’re not an employee, so there is no salary to be had; you are the company. Keep in mind that sole proprietors face liability concerns. You may sacrifice your pay for the well being of the company, only to get pummeled when a disgruntled client sues the company about something.

Biting the Bullet
Over the past few years, many remodelers have discovered that, as the saying goes, desperate times do call for desperate measures. Dale Nichols, of Artisan Remodeling, Granite Bay, Calif., has heavily reduced his salary. The design-build company is an S corporation, so Nichols does pay himself something.
“Survival is a legitimate business strategy,” he says. “I cut overhead as low as I can.”
Chris Teifke, of garage door specialist Joe Wilde Company, an S corporation in New Berlin, Wis., says, “I have laid off employees, cut the hours and pay of the remaining employees, and taken the biggest pay cut myself to keep our heads above water. While my pay is not zero,” it is low. “I don’t like it, but I have to focus on the future and not the here and now.”
At Quality Design & Construction, Raleigh, N.C., Peggy Mackowski went without pay for 10 months last year. Her husband, David Mackowski, continued to draw a salary from the S corporation, but Peggy says she “laid herself off as an attached employee.” She collected unemployment compensation and continued to work. “They can’t stop you from working for free,” she says. The company laid off two other employees who also received unemployment compensation. “My corporate unemployment rate will go up next year” because of the three claims, Peggy says, but “you do what you got to do to survive.”
During the early 1990s recession, Winans Construction, Oakland, Calif., had almost no work, says Paul Winans. The company (now under new ownership) was a C corporation. For two years Paul and co-owner Nina Winans took no salary. Instead, they kept a record of the wages owed to them. When business picked up, they began paying themselves again. Over time, they drew out the back pay as well.
One of the most dramatic stories comes from Ed Cholfin in Atlanta. He hasn’t received regular pay from his design-build company, AK Complete Home Renovations, in two years. The company is an LLC. To remain competitive, Cholfin says, “I reduced overhead to bare bones.” He not only eliminated his own draw, but also closed his showroom, cut 13 staff positions, and reduced the hours of his one remaining office employee. (He subcontracts construction.)
Now Cholfin says business is starting to pick up. He will begin paying himself again when he has a backlog of several healthy-margin jobs and sees more coming down the pike. “But I don’t need as much money as I took before,” he says. “I’ve changed my living habits. If you can work for yourself and be conscious of your finances, you probably will be more successful in business. It’s been an enlightening experience.”

Wendy A. Jordan, CAPS, has more than 30 years of experience covering the residential remodeling industry as an award-winning writer and trade magazine editor. She’s the author of many books on residential remodeling, most recently “Universal Design for the Home” and a 2009 edition of “The Paper Trail: Systems and Forms for a Well-Run Remodeling Company.”

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