One of the tax attributes of an S-Corporation over other forms of tax entities is the ability to reduce the overall tax obligation. Naturally the lower the overall tax requirement the more profit generated for the owner(s). The S-Corporation allows an owner to reduce their tax responsibility via the compensation package assigned to the owner.
How Much is a Fair Profit? Part I of V – Owner Compensation
In every small business there are one or two key individuals that not only provide the primary expertise but the labor investment as well. If the owner of the business works in the small business as an employee, how much does he pay himself? If he pays a reasonable compensation package to himself, then the compensation package has little to no effect on the fair profit percentage. If he underpays himself, then the profit percentage needs to be higher to offset this lower compensation package. If he overpays himself, then a lower profit percentage is expected.
A third factor in determining a fair profit percentage is risk. Risk is divided into two types. The first is insurable and the second is uninsurable risks. Insurable risks are mitigated and have very little to no effect on the profit formula due to transferring the risk to a third party known as the insurance underwriter. Uninsurable risks are non-transferable and therefore the profit must be adjusted to compensate for this type of risk.