Joe Biden used this strategy to trim his tax bill. You can, too.

Democratic presidential hopeful Former Vice President Joe Biden speaks during the second round of the second Democratic primary debate of the 2020 presidential campaign season hosted by CNN at the Fox Theatre in Detroit, Michigan on July 31, 2019.

Jim Watson | AFP | Getty Images

If you’re an entrepreneur looking to save a few bucks, consider borrowing a tax-planning tip from Joe Biden.

The former vice president and 2020 presidential contender and his wife Jill Biden reported about $10 million in income in 2017 from a pair of S-corporations, CelticCapri and Giacoppa. The two entities were paid for the couple’s book deals and speaking gigs.

The S-corps reported another $3.2 million in income in 2018.

While both S-corps generated a lot of income, they paid out modest salaries in comparison.

In 2017, the two companies paid the couple a combined $245,833 in wages. This increased to $500,000 in 2018.

That mean any amounts the Bidens received as a distribution wasn’t subject to the 15.3% combined Social Security and Medicare tax.

Here’s how it works. S-corporations pay their employee shareholders in two ways: wages and distributions.

“If you’re someone who is performing services for a business, they’re supposed to pay you a salary for it,” said Tim Steffen, CPA and director of advanced planning at Robert W. Baird & Co. in Milwaukee.

“But if you don’t report that income to the business as wages, then that portion of the income avoids Social Security and Medicare taxes,” he said.

Two ways to pay

Business owners can pay themselves a salary, which would be subject to self-employment taxes of 15.3% for Social Security and Medicare.

In 2019, wages up to $132,900 are subject to Social Security taxes, while Medicare taxes continue to apply beyond that amount.

Business owners can also take a distribution from the S-corp, which is tax-free up to the shareholder’s basis  — that is, the investment he or she has in the company.

Here’s an example: Your small business S-corp generates $1 million in income. You decide to take $100,000 of that business income in the form of a salary, reported on Form W-2.

The remaining $900,000 is reported on your business’s Schedule K-1, where it’s deemed your share of the company’s income.

There’s really been very little guidance on what this idea of compensation means and what’s reasonable.

Jonah Gruda

CPA and partner at Mazars

This shouldn’t be interpreted as a free-for-all for entrepreneurs.

Indeed, previous presidential candidates on both sides of the aisle were tripped up for paying owners relatively low salaries while generating millions in income.

The Internal Revenue Service requires that S-corp owners pay “reasonable compensation” to employee shareholders for services performed before making non-wage distributions to them.

That’s where things can get murky. “There’s really been very little guidance on what this idea of compensation means and what’s reasonable,” said Jonah Gruda, CPA and partner at Mazars in New York.

An appropriate salary

Entrepreneurs who deliberately mischaracterize their compensation face reprisal from the IRS if they’re caught.

Uncle Sam can recharacterize the distributions received as salary and demand payment of employment taxes and penalties.

Accountants have relied on different rules of thumb to help entrepreneurs come up with an appropriate wage based on the extent to which the business needs that individual.

One possibility is to divide the S-corp’s income so that a third of it goes toward business expenses, a third toward salary and a third toward distribution, said Gruda.

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He said there should be some flexibility.

“If you’re an artist, and 100% of your revenue is service-oriented, then one might say that 100% of your earnings should be salary,” Gruda said.

“On the other hand, maybe you have a capital-intensive S-corp and you develop software and there are other factors in how the revenue is derived,” he said.

A more conservative approach would be to take a salary that’s based on a national average of wages for that position, said Dan Herron, CPA and partner at Better Business Financial Services in San Luis Obispo, California.

Your salary should also reflect how important you are to your business.

“If you were a doctor who owns an S-corp, and if you were to remove yourself from the business, does your operation continue? No,” said Herron.

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