For example, if your company is an S corporation, it’s a bad plan to pay low wages to avoid payroll taxes.

This practice is on the IRS’s list of Dirty Dozen tax scams, and they look for it when they review your tax
return. If you pay yourself wages that are too low, you run a high risk of an IRS audit. During the past
two years they’ve audited the returns of thirty thousand S corporations based on this one issue. I
understand that everyone hates to pay taxes. Too often people use taxes as their excuse for bad
performance and say, “I made money, but then I had to pay it all in taxes.” Even if they are making
money, some business owners will do anything to avoid paying money to the IRS, even if it hurts their
business. There is never a case in which the entire next dollar of profit goes to taxes. The top federal tax
bracket is 35 percent, so you keep 65 cents on every dollar (before state taxes), and that’s a lot better
than nothing. If your company is an LLC, all of your profits are subject to employment taxes so the IRS
does not care how much you take in salary or distributions. But if your company is an S corporation, this
is a red flag because the IRS will say the distributions should be salary. Either way, you’re taking income
out of the business and decreasing profits that need to be left in the business to keep it healthy. One
thing I say to my clients all the time is that if you’re not paying taxes, there are only two possibilities:
You didn’t make any income or you’re cheating. Paying taxes is a good thing. The higher your tax bill, the
better your business is doing. This is your number one key performance indicator. You can’t create
legitimate wealth from an operating business unless you pay taxes. Your business’s number one key
performance indicator is this: How big a check did you write to the IRS this year? If you’re my client and
I’ve done my job, I can show you how much more money you made even though you paid taxes. I have
clients who paid $1 million in taxes, and I was able to show them that they still kept $2 million. A million-
dollar tax bill is no fun, but these clients created true wealth that could be traced to real money in the
bank. Beware of people who promise to lower your tax bill to 10 percent or less. They are using the
effective tax rate as a lure to have you spend all your profits to lower your tax bill. The eomp Aill.
Theffective tax rate refers to the amount of tax you paid divided by your total income before
deductions. Beware when people explain taxes this way, because they are luring you into spending
money on deductions as a way to lower your tax bill. You will pay less in taxes, but you will never build
any wealth. This is probably different from what you’re used to hearing from most accountants because
they tell you how to save on taxes. But if I’m saving you taxes because you spent your profit, am I really
saving you anything? Don’t focus so hard on not paying taxes. Focus instead on increasing your profits.
Of course, you have to plan carefully for taxes when you pay yourself a market-based wage. I’ll talk
about this in more detail in chapter 5, “Taming the Tax Monster Under Your Bed: Tax Management That
Works.” DETERMINING A MARKET-BASED WAGE You have to determine your market-based wage before
you can plug it into your financials. One of the greatest quotes I’ve ever heard is, “A man who aims at
nothing hits it with amazing accuracy.” I’ll help you figure out how to take aim with your salary
calculation and hit the target. As I go from city to city talking to entrepreneurs, I encounter an amazing
consensus that $30,000 is the acceptable owner’s salary. Why is $30,000 the magic number? I have no
idea, but it is far too low for the vast majority of business owners. One of my clients was paying himself
a $30,000 salary and taking large distributions. I recognized this as a problem and immediately advised
him to change his pay. A short time later, he received notice from the IRS that he was being audited for
unreasonable compensation. This salary doesn’t fly unless you really are doing a job that’s worth only
$30,000, in which case you’d better have some salary surveys to prove it. This situation can become very
expensive if you end up having to deal with the IRS. And if your job is worth only $30,000, why are you
doing it? No entrepreneurs I know truly believe their work is worth only $30,000. Determining what
your salary should be is confusing to many entrepreneurs. Here’s a common question I hear:
Entrepreneur: You said $30,000 is kind of a magic number. If I’m paying myself that wage now, how do I
determine if it really should be higher? Greg: Think of it like this: If you got run over by a bus today and
your heirs decided they would keep the business going in your absence, what would they have to pay
someone to do your job? There are plenty of salary survey websites. Some of the numbers might be
overinflated, even if you knock them back 10 to 20 percent. But even after adjusting them, it’s likely that
the numbers will still be significantly higher than what you’re paying yourself today. My practice
subscribes to the Economic Research Institute’s Salary Survey Assessor ( [Link]). It is one of
the main salary survey sites, and it’s the engine for most salary surveys. I’ve always been able to find a
relevant salary survey to give clients some direction without much difficulty. Another website to check
out is [Link]. We’ll disdiv A217;ll dcuss other ways to determine your market-based wage in
chapter 6, “How to Maximize Your Labor Productivity.” Because my practice has worked with so many
companies in so many industries, we have a pretty good idea of what a CEO should get paid. If you’re
doing $1 million in revenue, it’s unlikely that you’ll make $200,000 as the CEO. We typically look at
ranges to determine a CEO’s salary. You probably have one or two people in four or five key functional
roles in your business, so you should take a blended approach to setting salary levels. A great example of
this is a business where the CEO is also responsible for sales. The CEO function of a business with $1
million of revenue is not a full-time role and accounts for only 20 percent of the owner’s time. The
remainder of the owner’s time is spent on sales. If the owner takes a salary of $125,000 per year,
$25,000 is the CEO salary, and $100,000 is the VP of sales salary. You can see the problem that arises
when the CEO decides to hire a VP of sales. The CEO would have to take a salary cut. The solution is that
the CEO continues to sell along with the VP of sales, and the business grows faster so it can eventually
justify a full-time CEO. In a single-shareholder business, there are times when the shareholder can
decide not to take a market-based wage and remain within the IRS guidelines of reasonable pay. But I
still believe the profit card should always trump a tax strategy. A BUSINESS IS LIKE A COW Most people
know they’ve actively avoided the issue of paying themselves a market-based wage. But increasing their
pay sometimes leads to another question: I really should be making $100,000, but what should I do if I
can only afford to pay myself $30,000? If you’re not able to pay yourself a market-based wage so you
can see the true metrics of your business, you’re operating at a loss. You can’t let this phase go on too
long because you will eventually face two bad scenarios: a below-market wage and no return on your
investment. You need to devise a plan that will deliver you a market based salary and a good return on
your investment. In the next chapter, I’ll talk about how to fix an underperforming business. But for
now, it’s important to understand that if you are underpaying yourself, your business is sick. I like to say
that a business is like a cow. Until you pay yourself a market-based wage—and make a profit on top of
that—you have a sick cow on your hands. Your goal is to keep the cow healthy so you can milk it every
day. Or you can have one barbecue. Take your pick. In other words, your goal should be to create a
business that generates income for you every day rather than killing your business by taking out too
much income at one time. But don’t worry—I’ll show you how to keep your business (your cash cow)
healthy. SWEAT EQUITY You shouldn’t pay yourself a market-based salary when your business can’t
afford it. There’s a different way to pay yourself what you are worth without taking cash out of the
business. It’s called sweat equity. Sweat equity is the value you have created for your business through
your unpaid work. If your business should be paying you $100,000 per year for the job you perform in
your business, and it takes you two years before you can drawt. You can track your sweat equity and
make an adjustment when it comes time to do your tax return so it doesn’t distort your numbers. Or
you can calculate it separately in your financial performance metrics. I’ve found that most accounting
systems really struggle to give you the financial reporting you need for special items like tracking sweat
equity. Most of the time, you need to take data from an accounting system and put it in a format that
makes it readable. You’ll find some examples on my website, [Link].
MARKET-BASED WAGES FOR ALL Now is a good time to talk about market forces in relation to this
question: Entrepreneur: Does the market-based wage apply only to you as a shareholder, or does it
apply to affiliates as well? Greg: Market-based wages apply to everybody, not just the shareholder. If I
hire an employee at below-market rate, market forces dictate that I’m not going to keep that person
forever, and replacement will be more costly in the long run than hiring that employee at the market
rate. A high turnover rate is very, very expensive. It also makes it hard to create consistency in the
workplace, which can lower productivity, service quality, and customer satisfaction (this is also
expensive). If you’re a multi-shareholder company, market-based wages can become a real issue. Here’s
a scenario I’ve seen many times. Three guys have been buddies forever, and they’re ready to start a
business: First buddy: Okay, there are three of us starting this business. Greg: Sounds great. What’s the
ownership going to be? Second buddy: Oh, it’s one-third each. Greg: Really? Is everybody going to put in
the same amount of money? Third buddy: Well, two of us are going to put in a little bit of money, but
Bob’s not going to put in any money. But we really need him to be part of the busi