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Using ChatGPT to Determine S Corporation Reasonable Compensation

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You can use ChatGPT to set S corporation reasonable compensation.A disclosure to start this discussion about using ChatGPT for determining S corporation reasonable compensation. I do not think the large language models like ChatGPT do a great job with tax accounting or tax law.

They  don’t. Or at least not yet. And maybe never.

But if you’re an S corporation owner? And you’re struggling to set a shareholder-employee salary? Because ChatGPT does its work for free, and because it’ll often do an adequate job, I think you and I can use it. Its calculations and conclusions should often result in a reasonable compensation number.

But let me step you through the process I’d suggest.

The Trick is Your Prompt

You may already know this. But you ask an AI (artificial intelligence) model like ChatGPT questions.

You can for example ask a question like, “What is the average salary of a carpenter?” Or, “how much does a preschool teacher earn?”

These questions then prompt the AI. And then it returns your answer.

The trick to getting a usable S corporation reasonable compensation number? Providing a good prompt.

For example, a carpenter working as a small contractor in (say) Mount Vernon, Washington might ask, or prompt, the AI with a question like this:

I work as a carpenter and project manager for a small construction company in Mount Vernon, Washington. I have several years of experience. The firm’s total revenues fall between $500,000 and $1,000,000 a year usually. We do small home remodeling jobs. What would be the range of reasonable salaries for this position as well as common fringe benefits? Please cite your sources.

You want, as the above prompt does, to provide as much detail as you can. Also, ask the AI to provide citations for its sources.

When I asked ChatGPT this question in August of 2024, by the way, it provided the following answer—which seems good enough:

In your role as a carpenter and project manager for a small construction company in Mount Vernon, Washington, several factors influence salary expectations, including the size of the company, your level of experience, and regional economic conditions.

Salary Range

For a position combining carpentry and project management at a small firm, here’s a reasonable salary range:

  • Salary Range: $60,000 to $90,000 annually.

Breakdown:

  1. Carpenter with Project Management Duties: Given your extensive experience and dual role, your compensation would be on the higher end of the scale for similar positions in the area. In Washington state, the salary range for a carpenter typically falls between $50,000 and $75,000. Adding project management responsibilities increases this range.
  2. Regional Factors: Salaries in Washington can be higher compared to other states due to the higher cost of living and strong demand for skilled trades. Mount Vernon, being a smaller city, might have slightly lower wages compared to larger urban centers like Seattle, but the difference isn’t substantial.

Sources:

  • Bureau of Labor Statistics (BLS): Data on carpenters and construction managers provides baseline figures, with carpenters earning an average of around $60,000 annually, and project managers potentially earning significantly more, especially with specialized skills.
  • Indeed & Glassdoor: These job sites provide salary insights specific to roles in the construction industry, with regional variations factored in.

Common Fringe Benefits

  1. Health Insurance: Many companies offer health insurance as a standard benefit. This can vary in terms of coverage and the percentage of costs covered by the employer.
  2. Retirement Plans: 401(k) plans are common, sometimes with employer matching contributions.
  3. Paid Time Off (PTO): This includes vacation days, sick leave, and personal days. For your level of experience and role, around 10-15 days of PTO annually is typical.
  4. Tool Allowance or Reimbursement: Given your role involves carpentry, some firms provide allowances or reimbursement for tools and equipment.
  5. Professional Development: Some companies support continuing education or training relevant to your job.
  6. Overtime Pay: If you work beyond standard hours, overtime pay is usually applicable, though this can depend on the company’s policy and your specific employment status (exempt or non-exempt).

Sources:

  • Society for Human Resource Management (SHRM): Provides benchmarks for typical fringe benefits offered by employers.
  • Industry Surveys and Reports: Various reports and surveys on construction industry compensation and benefits offer additional insights.

Additional Considerations

  • Negotiation: Given your experience and dual role, you might have room to negotiate a higher salary or additional benefits.
  • Company Size: Small companies often have less flexibility in salary but may offer other types of compensation or benefits.

These figures and benefits are approximate and can vary based on specific company policies and regional economic conditions.

Thus, I think a small construction company owner who works in Mount Vernon, Washington and who both manages profits and works on the job site as a carpenter might reasonably pay her or himself $60,000 to $90,000 in 2024.

Note: We don’t to my knowledge serve any construction companies operating out of Mount Vernon, Washington. I picked that location because it’s close to where I grew up.

Two Follow-Up Tips

Two follow-up tips if you want to use ChatGPT to set S corporation reasonable compensation.

First, you and I ought to be doing this every year, right? We can save money with an S corporation. But one of the most important rules is, you must set shareholder-employee compensation to some reasonable amount.

Second, save your prompt and the AI’s response as a document. Store it with your payroll records. This document can become something you reference if the Internal Revenue Service or an equivalent state agency ever questions you.

Other Resources Related to S Corporation Reasonable Compensation

A handful of blog resources here you might find useful. First, we’ve got an S corporation tax savings calculator you can use to determine whether you save money with an S corporation. Use that if you’re still researching this idea of reorganizing your business as an S corporation. And then here’s a full list of our S corporation blog posts.

Second, we’ve got a blog post from a few years ago about how to set a safe reasonable salary for an S corporation shareholder-employee: S Corporation Reasonable Compensation. That’s worth reading for a little more detail on the bookkeeping.

And then the Internal Revenue Service provides a helpful summary here: IRS Fact Sheet on Wages for S Corporation Officers. That should be required reading.