A quality of earnings (QoE) report treats owner compensation in two steps. First it adds back what the business actually paid the owner, including salary, payroll taxes and benefits, using figures that tie to payroll records and the tax returns. Then it deducts a replacement salary, which is the estimated market cost of hiring someone to do the owner's job, built from wage data plus payroll taxes and benefits. The difference between the two is the owner compensation adjustment. Showing both steps separately lets the buyer and the lender see what was paid and what was assumed, and argue about the assumption on its own terms.
In a small business, what the owner takes out is often set by tax planning, cash needs or habit, not by what the job would cost on the open market. One owner takes $300,000 in wages. Another takes $40,000 and the rest as distributions. Neither figure tells a buyer what it will cost to run the business after closing.
EBITDA is meant to show earnings after a market-rate cost to manage the business. If the owner's pay is above market, reported earnings are understated. If it is below market, or missing from the profit and loss entirely, reported earnings are overstated. The adjustment moves the figure to a market cost so the earnings can be compared and priced. The difference between this and SDE, which adds back one owner's full compensation with no replacement, is covered in SDE vs EBITDA.
Owner compensation is more than the salary line. A QoE gathers the full cost of the owner from the payroll registers, the W-2s, the general ledger and the tax returns. Common pieces include:
Where the money shows up depends on the entity. On a corporate return, owner wages usually appear as officer compensation. On a partnership return, they often appear as payments to partners for services. For a sole proprietor or single-member LLC filing on Schedule C, the owner's draws are not an expense at all, so there is nothing to add back, and a replacement salary has to be deducted to reach EBITDA. Distributions to owners are not an expense on the profit and loss in any of these cases. How the entity type affects your own deal is a question for your tax adviser.
The add-back is the historical figure, so it has to tie to records. The QoE compares owner wages on the payroll reports to the W-2s and to the compensation lines on the filed returns, year by year. Benefits and perks are traced to the general ledger and, where possible, to invoices or statements. If the owner's pay changed partway through the review period, the add-back follows the actual amounts by period rather than one annual figure.
When an amount cannot be tied to a payroll report, a return or a ledger entry, the report says so and lists the item as an open question in the Q&A. It does not estimate the missing figure. The broader standard for which adjustments hold up is covered in which add-backs survive diligence.
The replacement salary is an assumption, so the QoE shows how it was built. The usual starting point is the Occupational Employment and Wage Statistics program from the U.S. Bureau of Labor Statistics, which publishes mean and median wages by occupation for the nation, for states and for metropolitan areas. The most recent estimates cover May 2025. The QoE picks the occupation that matches what the owner actually does, such as a general and operations manager, and uses the wage for the company's area where one is published.
The employer also pays payroll taxes and benefits:
| Cost component | How it is estimated | Source |
|---|---|---|
| Base wage | Occupation that matches the owner's duties, in the company's area | BLS Occupational Employment and Wage Statistics |
| Social Security tax | 6.2% of wages up to $184,500 for 2026 | Federal payroll tax rules |
| Medicare tax | 1.45% of all wages | Federal payroll tax rules |
| Unemployment taxes | Federal and state rates on a limited wage base, which vary by state | The company's payroll filings where available |
| Health and other benefits | The company's own plan cost for a manager, where one exists | The company's benefit invoices, or a stated assumption |
For a sense of scale, the Bureau of Labor Statistics reported that benefit costs, which include employer payroll taxes, were 30.0% of total compensation for private industry workers in June 2026.
Duties matter as much as the wage table. An owner who works 60 hours a week as both general manager and lead estimator may take two hires to replace. An owner who checks in once a week with a general manager already on payroll may need little or no replacement. The QoE asks the company what the owner does in a typical week and states the basis for the role it priced.
Family members on payroll are tested the same way. The QoE asks what work they do and how many hours they spend on it. Wages paid to a family member who does not work in the business are added back along with the related payroll taxes. If the family member does real work, the adjustment is the difference between what they were paid and the market cost to replace that work, which can be higher or lower than their current pay. The report shows both the historical figure and the replacement assumption.
These are round, invented numbers for illustration only. A company reports EBITDA of $400,000. The owner is paid a salary of $180,000 with $20,000 of health and other benefits. The owner's spouse is paid $50,000 and spends about ten hours a week on bookkeeping. The company's area wage for a general manager is $110,000, and a part-time bookkeeper would cost about $25,000.
| Line | Historical cost (added back) | Replacement cost (deducted) | Net adjustment |
|---|---|---|---|
| Owner salary | $180,000 | $110,000 | $70,000 |
| Owner payroll taxes | $13,770 | $8,915 | $4,855 |
| Owner benefits | $20,000 | $18,000 | $2,000 |
| Spouse wages and payroll taxes | $53,825 | $26,913 | $26,912 |
| Total | $267,595 | $163,828 | $103,767 |
Payroll taxes on the historical side are 7.65% of wages. On the replacement side, the owner's role carries 7.65% plus an assumed $500 of unemployment taxes, and the bookkeeper carries 7.65%. Adjusted EBITDA rises from $400,000 to $503,767. At a multiple of 3.5x, that adjustment is worth about $363,000 of price, which is why the replacement assumption draws scrutiny. A replacement wage $20,000 higher would cut the adjustment by about $21,500 once payroll taxes are included.
Lenders underwrite the loan on cash flow, and the owner's pay is part of that cash flow. If the buyer plans to run the business, the lender may look at whether the cash flow covers both the debt and a reasonable living for the buyer. If the buyer plans to hire a manager, the lender may want the full replacement cost in the figures. How coverage is measured is covered in how SBA lenders calculate DSCR. How a given lender treats the replacement salary is a question for that lender.
On SBA loans under SOP 50 10 8.1, effective October 1, 2026, a QoE is required for Initial Acquisition and Business Expansion loans where the business purchase price is $3 million or more. The report must come from an independent financial professional engaged by and acting on behalf of the lender.
In our reports, the owner compensation adjustment appears as two lines on the adjusted EBITDA schedule: the historical cost added back and the replacement cost deducted. A supporting schedule shows the records behind the add-back and the assumptions behind the replacement. Any figure that could not be tied to a document is stated as such, and open questions go to the Q&A tab, which the buyer should review in full. The layout is on the sample report page, and the procedures are on the quality of earnings page.
We have completed more than 600 QoE engagements and take on about 40 a month.
For EBITDA, yes. Your time has a cost, and the next buyer or a lender will look for it. SDE leaves the owner's pay in the earnings, so the figure is higher, but the buyer still has to live on part of it. Ask your lender which figure it underwrites.
Then the adjustment reduces earnings. The QoE adds back the low actual pay and deducts the higher market cost, so adjusted EBITDA comes out below reported EBITDA.
No. A QoE is not an audit and gives no opinion. It states the wage source, the role it priced and the tax and benefit assumptions, so the buyer and lender can test them or substitute their own.
Our fee is $7,500 flat for SBA-sized deals, whether or not SBA financing is used, and larger deals are scoped and priced to the work after a call, with the fee quoted before work starts. There is no hourly billing. The work generally takes two to four weeks from receipt of documents. Details are on the pricing page.