Your S Corp payroll can save you MONEY! As an S Corp shareholder, you are required to be on the companies payroll. Let’s look at the best way to “pay” yourself as an S Corp owner.
Introduction
S Corporations (S Corps) can be looked at as a great blend of a pass-through taxation and liability protection.
What this means is you have an entity that pays tax like an LLC (or partnership), but gives you the business structure of a corporation.But as an S Corp, you are required to be on payroll. This allows you to set your payroll salary at a level which the IRS would be happy with, but also allows for distributions, which save on payroll taxes.
Navigating the intricacies of payroll as an S Corp owner is important for compliance and tax savings. Let’s check out a few strategies that help S Corp owners make the most of their payroll structure.
S Corp Payroll
You must be on payroll if you actively participate in running the business and are a more than 2% shareholder. This is only a requirement if you actively work in the business. If you don’t actively participate in the business, you aren’t required to be on payroll.
This balance of compliance with IRS regulations is the key to maximize your tax savings. The key lies in determining a reasonable salary and strategically utilizing a mix of salary and distributions.
What is a “Reasonable Salary”?
This part of your S Corp payroll is required. This is always the hard part. Mostly because the IRS has no real guidance other than the wage must be “reasonable”.
The easiest way to establish a baseline is to determine what you would pay someone to do your job. Put together a job description and we can use that to research comparable pay.
To establish what a “reasonable salary” is for your specific business, you should consider industry standards, their skills, experience, and responsibilities to avoid the risk of “unreasonably low” salaries.
When I’m assisting a client with finding their “reasonable salary”, I always review what other companies are paying. Indeed.com, Salary.com and Payscale.com are a few sites I look through.
Another consideration is the success of the business in question. If you can’t afford, or the business doesn’t generate enough income to pay a salary based on your findings, then pay less.
Generally, a shareholders salary must be at least 50% of your net earnings before paying yourself.
You Are Tax Planning Even If You Didn’t Know It.
Finding the best balance between your salary and distributions is the ultimate in tax planning.
I’ll tell you why.
If you take all of your profits via payroll, you are paying more in payroll taxes than really required.
Let’s pretend you made $100,000 in net income (before payroll) last year. Your net take home pay in this example would be around $71,500. I used California as the state. A Digital Nomad (i.e. no state return filed) would end up with about $76,500.
Optimizing payroll for S Corp owners involves finding the right balance between salary and distributions. Understanding the advantages of each and utilizing business deductions are essential for minimizing taxable income and maximizing tax efficiency.
If you determined your salary should be $50k (instead of $100k), you would be right at a 50/50 split between salary and distributions. This would save (in payroll taxes) about $4,000.
See. Tax planning.
You Must Comply With IRS Requirements
Congress recently passed legislation which increased the IRS budget by $79.4 billion over the next 10 years (this is in addition to the annual budget given for operations).
One of the things they will use this money for is audits of S Corps, specifically as it relates to shareholder payroll. This is low hanging fruit and can generate billions in payroll taxes and the related penalties and interest involved.
I have started seeing these audits and the IRS is taking a position that ALL of your net income should be paid out using payroll. The best course of action is to pay yourself with a nominal salary. You can pay yourself a bonus periodically to increase your pay to reflect at least 50% of net income.
I don’t advise simply paying yourself a small salary each month, taking the rest in distributions. You are in no better of a situation if your pay balance is 10/90% (payroll/distributions) vs 45/55%. You’ll mitigate penalties and interest, but this will be a minor expense related to the actual payroll taxes.
Employee Benefits for S Corp Owners
If you are an S Corp shareholder, the only legal way for you to receive benefits would be via payroll.
Without a paycheck, you can’t contribute to a Solo 401K or SEP plan.
If you’re not on payroll, you can’t get an auto supplement.
Without a paycheck, you won’t be able to deduct your health insurance.
If you pay yourself via payroll, you open up the world of benefits you can receive as an employee of your own corporation.
Without a paycheck, your corporation cannot pay for benefits on your behalf. If you do, you must 1099 yourself for the amount paid out. You will report this income on your personal income tax return as self employment income.
Should You Hire an Expert?
There are two parts to this question:
1 Determine a salary amount which you can show is “reasonable”
2 Run your S Corp’s payroll at least monthly (this is the legal minimum).
You should be able to determine a reasonable salary by using one of the salary sites I referenced above. Be sure to save your research in the event the IRS questions the amount of salary you give yourself. You will need a persuasive argument when dealing with the IRS.
Where you should consider an expert is in the preparation of payroll. While the actual calculation is easy (heck, there are hundreds of web pages to calculate your payroll). The important part is tracking and reporting your payroll each quarter. I advise your payroll reports be prepared by an expert.
I haven’t had many clients in my career who were able to properly calculate AND report payroll. Payroll tax issues are also one of the most prevalent issues small business owners experience. Let a pro handle this aspect of your business. This also frees you to make more money.
A Simple Case Study
You will see the benefits of this even with a simple situation. In this example, it’s just me. Not as a licensed tax professional, but as a guitar player.
I’m an ok player and have a few set gigs a week, with the occasional event. I’ve been around a while and have made $100,000 each year for the past 5 years (just to make the math easier).
Earlier, we noted that a $100k salary would give you about $71,500 after taxes were withheld. Cutting your salary in half saves about $4k in payroll taxes.
It really is that simple. The complication is figuring out what your MINIMUM salary can be. The balance between compliance and savings. This is a personal calculation. If you can prove your salary amount is reasonable, the rest can be taken as a distribution saving payroll taxes from being paid out.
Conclusion
Figuring this out is the easiest way to save real money with tax planning.
You must comply with S Corp payroll requirements for active shareholder participants. This fancy talk for “pay yourself what you’d pay someone else to do your job”.
Your salary should be AT LEAST 50% of what your net earnings are for any given period. I’ve spoken with auditors who use a 75/25 split to start. I would negotiate this down to be closer to the 50/50 split.
The easiest way to do this is to set yourself up with a nominal salary to be paid every month. Give yourself a bonus every quarter that increases your pay to the 50% figure we aim for.
You must pay yourself as an employee if you work for your S Corp. You may as well do it right and save a little money!
That’s it for now. Hit me up if you have questions. Until then, stay cool.
JKC