So, your sister-in-law was downsized and needs a new job. Your company is the perfect place for her to work, but how do you create a compensation package that is fair to her and to your other employees and keep yourself out of trouble with the IRS?
According to Ray Dunkle and Paula DiVencenzo, senior managers with Bober, Markey, Fedorovich & Co., there are key economic and psychological factors business owners must face when deciding the proper compensation for family-member employees.
DiVencenzo says the emotional component of these situations makes it harder to place a value on family member compensation relative to that of other key employees, so it’s best to start with what the market pays.
“If you follow the market approach and those key employees know about your compensation structure, they know that any family member coming into the environment is working at market rates,” says Dunkle.
Dunkle suggests investigating market rates by contacting an industry trade organization or using a salary survey, like those the IRS uses from Economic Research Institute. These numbers will give a base line for compensation levels.
Another problem DiVencenzo sees is when one family member employee is being paid too much while the owner is being paid too little. Businesses can find themselves in trouble for that and other reasons regarding overpayment and underpayment, and a lot rests on how the company is organized.
To avoid paying more taxes, C Corp owners pay out more in wages and less in dividends and distribution, which are taxed twice — as a profit by the company and as income by the individual. But this can send up a red flag for the IRS and signal an audit.
S Corp owners attempt to let more income flow through and take less compensation, which also causes the IRS to take notice.
“With S Corps, most of the time, the IRS will come in and say, ‘You’re being undercompensated.’ And on a C Corp, it’s the opposite,” says DiVencenzo.
Constantly monitor and re-evaluate compensation packages in order to stay within IRS standards.
Sometimes bringing a new family member into the company creates a great opportunity to re-evaluate the compensation packages of current family and other key employees.
“What they need to be concerned about is, there is good chance there will be some resistance to change,” says Dunkle.
On the other hand, equal pay can create a sense of teamwork among family members.
“For example, you have three siblings working for Mom and Dad,” says Dunkle. “They all know they’re getting paid the same. No one feels slighted; no one gets a big head because he or she is getting paid more. They’re all in the same boat, so they work together.”
The downside is that not all siblings are motivated to the same extent.
“If you do have equal pay, and some people are working harder than others, that can definitely create some animosity,” says Dunkle. “Having a bonus system in place to make up the difference in effort can make sense for family business owners.”
The most important step for owners of family companies is to develop a compensation philosophy that articulates what they believe. That philosophy should be shared among the employees, especially among the family members.
“Whether their compensation philosophy is geared around generating profits for the business or to reward productivity or to fund the next generation, communication is key,” says Dunkle. How to Reach: Bober, Markey, Fedorovich & Co., (330) 762-9785 or www.bobermarkey.com
