- IRS Scrutiny: The IRS often looks at year-end compensation to see if it’s reasonable. Doing your analysis before year-end helps ensure you comply and have documentation ready if you’re ever audited.
- Year-End Planning: By the second half of the year, you have a much clearer picture of how the business is performing. This allows you to make informed decisions about compensation before the year closes.
- Updated Financials: Most companies have their financial statements for the first half of the year ready by the third quarter, giving you solid numbers to work with.
- Tax Strategy: Adjusting compensation before year-end can help optimize tax outcomes for both the business and the individual, since salaries are deductible business expenses if they are reasonable.
- Bonus Decisions: Many companies pay bonuses at year-end. Analyzing compensation in the third or fourth quarter lets you decide if a bonus is appropriate and how much it should be.
- Avoiding Surprises: If you wait until after the year ends, you might find out too late that compensation was too high or too low, which can cause tax or compliance problems.
- Benchmarking: By the third and fourth quarters, industry salary surveys and benchmarking data for the current year are usually available, making your analysis more accurate.
- Cash Flow Awareness: You know by the second half of the year how much cash the business has available, so you can set compensation at a level the company can afford.
- Dividend Planning: For S corporations and C corporations, the split between salary and distributions/dividends is important for tax reasons. Year-end analysis helps you get this balance right.
- Retirement Contributions: Many retirement plan contributions are based on compensation. Analyzing compensation before year-end ensures you maximize retirement benefits.
- Fringe Benefits: You can coordinate salary with other benefits (like health insurance or deferred compensation) before the year ends.
- Performance Reviews: Many companies do annual performance reviews in the second half of the year, which is a natural time to review and adjust compensation.
- Budgeting for Next Year: Year-end compensation analysis helps set the stage for next year’s budget and payroll planning.
- Legal Compliance: Some states have minimum salary requirements for certain positions. Reviewing compensation before year-end helps ensure compliance.
- Shareholder/Partner Relations: For businesses with multiple owners, year-end is a good time to make sure compensation is fair and in line with each owner’s contributions.
- Documentation: Analyzing year-end means you can document your reasoning and decisions while everything is fresh, which is essential if you ever need to justify your choices.
- Audit Preparation: If your business is audited, having a recent, thorough compensation analysis is strong evidence that your salaries are reasonable.
- Profit-Sharing: If your company has a profit-sharing plan, you’ll know by the end of the year how much profit is available to share, and can adjust compensation accordingly.
- Avoiding Payroll Surprises: Adjusting compensation before year-end helps avoid last-minute payroll issues or errors.
- Peace of Mind: Finally, doing your analysis in the third or fourth quarter gives you time to make any needed changes, so you’re not scrambling at the last minute or after the fact.
In summary:
The third and fourth quarters are the “sweet spot” for reasonable compensation analysis because you have the most up-to-date information, the ability to make changes before the year ends, and the opportunity to optimize tax, legal, and business outcomes. It’s all about being proactive, not reactive—so you can finish the year strong and start the next one on solid ground.
