As margins continue to grow, so do year-end payouts of profits to construction company owners. As of December 2016, contractors with revenues of $25 million to $100 million reported an average bonus payout of $183,813 for the president position. In contrast, the three highest reported bonus amounts (same revenue range) averaged a payout of $891,66—more than four times the average of their colleagues. And that’s on top of their base pay and any deferred compensation. Kudos to those three presidents. Their bonus payouts are remarkable and a good thing, but if not handled correctly and planned for in advance, could turn into problems down the road.
Bonuses are something that most contractors haven’t had to worry about since the downturn in 2008. But now, with each year becoming more profitable than the previous year, larger year-end payouts increase a contractor’s chance of being questioned about what’s reasonable compensation. It might be a shareholder challenge or domestic dispute, but most likely it will manifest itself as an IRS issue.
For S-Corps, it’s important to differentiate compensation for services performed versus a distribution. Since only compensation is subject to payroll taxes and withholding, some S-Corp shareholders may try to take distributions but not direct pay. That low base pay is a trigger for an outside review. In C-Corps the typical target is the highly paid, shareholder-employee of a closely held corporation with no dividends. If generous salaries and bonuses to owner-employees appear to evade the double tax on dividends, red flags are raised. The action most likely to attract unwelcome attention is low base pay followed by an enormous year-end bonus.
It’s been a long-standing industry practice for many construction company owners to take little during lean years and then make themselves whole in good times when their firm becomes profitable. To someone unfamiliar with the industry’s ups and downs, such reimbursement can look suspicious. Without a way of showing such practices are normal, owners leave themselves open to unreasonable compensation charges.
There are a number of steps contractors can take to protect themselves, but the three that stand out are prior planning, historical practices, and monitoring industry standards. Determining a compensation rate or formula well in advance of the fiscal year end, before profits can be predicted, is a great place to start. Work with your CPA, compensation consultant, or legal advisor to set up a plan of how pay will be handled for at least the next 12 months.
Secondly, document each year that the owner-employee deliberately worked for far less than normal pay in anticipation of being “made whole” in the future for these years of under-compensation. And lastly, look for competitive analyses proving that other firms of similar size in the same industry paid similar compensation for similar work during the same periods.
Compensation giants such as Willis Towers Watson, AON Hewitt, ERI, and Mercer HR can be excellent sources of executive compensation information. For construction resources, both FMI and PAS offer contractor-specific executive pay data. Also check with your local CPA or construction association. This is a time when more information is better.
And, oh by the way, you are the market. So if you have a great year or a bad one, participate in industry surveys to establish what “normal” is. It will only benefit you in the end.