Are you the owner of a limited liability company (GmbH) and at the same time its managing director? Then, in addition to any annual dividend, you will also receive a monthly managing director’s salary. But, how do you determine the salary amount?
Do you have to follow specific industry guidelines or can you just set it at any amount? From a tax perspective, are there any important points to consider here?
As you can see, there are more questions about the managing director’s salary than you might think at first glance.
As a tax consultant in Hamburg, I am also regularly asked by my clients about this particular issue.
In addition to asking about the correct salary, my clients frequently want to know about company pension schemes too. As a company owner, it is more difficult to make provisions for retirement given planning uncertainty, and many entrepreneurs are particularly apprehensive about this.
In this blog post I will deal with these frequently raised concerns. You will learn:
- Where the managing director’s salary is determined
- How high it should be (including a case study)
- How to set up your company pension with the right salary strategy
Don’t worry: You don’t have to be a tax professional to follow my tips. I have largely avoided technical terms and explain complicated issues by drawing on examples.
This post was updated on 5 August 2021.
Where is the managing director’s salary determined in a limited liability company?
The managing director’s salary is always agreed in the managing director’s employment contract.
If you hire someone to be the managing director of the GmbH, the salary is regulated in the employment contract together with the person’s responsibilities, vacation entitlement and the duty to maintain confidentiality.
If you, as the owner of the GmbH, assume the position of managing director, you will also have a separate managing director’s contract.
This effectively gives you two roles in your company:
- Majority shareholder:You represent the interests of the equity investors and are responsible for ensuring that these shareholders achieve a return on their invested capital.
- Managing Director:You are responsible for the operations and strategic planning and thus determine the development of the company.
If you perform both activities yourself, there is usually no conflict of interest between these two roles.
In the case of large GmbHs or stock corporations (AGs), however, there are very often differences of opinion between management and the shareholders.
How high should I set the managing director’s salary at my GmbH?
Unfortunately, there is no general answer to this question. Basically, by law you are not required to pay industry standard compensation and you do not have to adhere to any average salaries or pay scales.
Therefore, you are free to determine the managing director’s salary. However, two conditions must always be met:
Condition 1: Your company has to have sufficient financial resources
The basic prerequisite when determining the managing director’s salary is, of course, that your GmbH can actually pay you the salary without facing financial ruin.
A rule of thumb for you: 50% of your company’s profit should always stay within the company. The managing director’s salary should therefore not exceeded this 50% threshold.
If, for example, your GmbH makes a profit of €500,000 per year, you should not be paying your managing director an annual salary of more than €250,000.
Condition 2: You must always bear in mind the so-called arm’s length principle
Ask yourself the question: What would the salary be if the managing director was someone else?
Of course, there is no single correct answer to this question. Answer the arm’s length question honestly and objectively for yourself. Then set an approximate range.
As the owner/managing director, your salary should then be within this range. If you do this, you’ll be on the safe side.
Please note: The arm’s length method does not only refer to salaries that might be too high. The tax office might even question a salary that is too low.
Determining the salary of a managing director of a GmbH based on a case study
Let’s assume that your company makes an annual profit of €500,000. Since we can also assume that at least 50% of this amount should remain in the company as residual profit, your managing director’s salary can amount to a maximum of €250,000.
Now you still have to think about the arm’s length principle: If you would pay an employed managing director a salary of between €50,000 and €80,000, then your salary as an owner/managing director should also be in this range.
But beware: You are not allowed to change the managing director’s salary at will. If it looks like your company is going to make a lower profit, it is actually forbidden to reduce the managing director’s salary during that year.
You may only make changes that would also be acceptable to a third party employee. And they would probably not agree to a sudden pay cut or change in their monthly salary.
How to use the GmbH managing director’s salary as an instrument for a company pension scheme
The company pension scheme is always salary based. The maximum contribution to a pension scheme is one third of your salary. This means that the higher your managing director’s salary is, the more you can provide for your retirement.
This is where a popular trick comes into play: In order to guarantee that a large amount is paid into the company pension scheme, the managing director’s salary as specified in the employment contract also has to be high.
However, you do not have to pay yourself this salary in reality. This is because you can waive part of your salary without losing the large amount paid into the company pension scheme.
In reality, it might work something like this:
You give yourself a managing director’s salary of €100,000. The maximum amount you can pay into the company pension scheme is therefore €33,333. However, you can waive half your salary and pay yourself only €50,000.
The maximum amount payable into the company pension scheme still remains at €33,333.
In this way you can provide for your retirement without allowing too much money to flow out of your GmbH.
All details about managing director’s salaries are explained in this video
Would you like a more personal explanation of managing director’s salaries? Then I can recommend my video on this topic.
In the video, I discuss everything you as a business owner need to know about managing director’s salaries with my colleague York. Just press play!
Conclusion: The right managing director’s salary makes it easier for owners to take part in the company pension scheme
Legally, you can set the level of the managing director’s salary (almost) entirely as you wish.
In practice, however, two main rules of thumb apply to determining the salary:
- Set the managing director’s salary so that at least 50% residual profit remains in your company.
- The managing director’s salary should stand up to an arm’s length comparison.
If you comply with these two conditions, your salary cannot be criticized.
If in doubt, it is best to discuss the size of your salary with an experienced tax consultant. A qualified recommendation is only possible as a result of thorough analysis.
General statements are just not reliable and not really helpful.
If you are interested in such an analysis and would like to know what the right managing director’s salary for your GmbH is, please feel free to contact me.
You can reach me at any time via phone (+49 040 443311), e-mail (anfrage@steuerberatung-breit.de) or my contact form.
Kind regards,
Thomas Breit
Photo: © baranq – stock.adobe.com
