How to Pay Yourself as an S Corp

concept image - a stack of coins is balancing on a block of wood to represent being paid as an s corp

S Corporations are unique in that they offer both the limited liability benefits of a corporation and the pass-through taxation of a partnership. In an S Corp, paying yourself generally involves a combination of a salary as an employee and distributions as a shareholder.

However, because the IRS is attuned to anything that might appear to be an attempt to evade taxes, it’s important to ensure that you’re paying yourself reasonable compensation for the value you provide your business. Below, we discuss more about your S-corporation compensation options and how to ensure you remain compliant with federal rules and regulations.

S Corporation Compensation Options

 

First, it’s important to assess your role in the S Corporation. If you’re an owner who plays a crucial day-to-day role in the business, you’re generally classified as a shareholder-employee. If you’re an owner who doesn’t have a day-to-day role in your business, you’re just a shareholder.

When it comes to paying yourself in an S Corporation, you can choose from among three options, depending on your status as shareholder or shareholder-employee. First, for shareholder-employees, you can pay yourself a salary—just as you’d pay any other employee. Employment taxes should be withheld from this salary and remitted to the IRS.

Your second option is to pay yourself distributions from the business. If you’re a shareholder but not a shareholder-employee, you’re able to receive your profits as distributions—and unlike a salary, these distributions aren’t subject to employment taxes. (It’s important to note that distributions that exceed the shareholder’s stock basis are still taxed as income.)

Finally, shareholder-employees can also opt for a combination of salary and distributions. Many S Corp owners choose this option when they prefer at least part of their compensation to be based on business performance from year to year. It’s important to remember that you shouldn’t take distributions that would jeopardize the financial health of the business.

And again, it’s critical for the shareholder-employee’s compensation to be considered reasonable for the services provided. We’ll explain more about the importance of reasonable compensation below.

How Can You Determine a Reasonable Salary?

As an S Corporation shareholder who is also actively working in the business, you must pay yourself a reasonable salary for the services you provide. This is to ensure that you’re paying payroll taxes appropriately and not avoiding Social Security and Medicare taxes (also known as FICA taxes).

A businessman sitting at his computer completing payroll to pay as an s corp

Some S Corporation owners may try to reduce their overall income taxes by taking most of their income in distributions while paying themselves an artificially low salary. But the IRS sees this tactic as an attempt to evade taxes. In the most serious cases, this can even be considered a crime. And if the IRS determines that you haven’t been paying yourself reasonable compensation, any non-qualified distributions could be reclassified as income—and subject to employment taxes, penalties, and fees.

To establish your reasonable salary, you should research what similar roles are paid in your industry and geographical area. This salary should reflect what you would pay an unrelated third party for the same services.

One source for this research is RCReports. Our reasonable compensation reports combine IRS criteria, court precedent, and a proprietary wage database to provide tailored, accurate, and legally defensible reports outlining reasonable compensation for a wide variety of industries and business types.

Declaring Your S-Corporation Salary on Your Taxes

 

When you’re an S Corp shareholder and employee, you need to declare your salary on your taxes correctly to ensure compliance with tax regulations. Here’s a general overview of how to declare your S-corporation salary on your taxes:

Form W-2

As an employee of the S Corporation, you’ll receive a Form W-2 from your company at the end of the tax year. This form summarizes your salary, wages, and withheld taxes. You’ll use the information on this form to report your salary on your personal tax return.

Personal Income Tax Return

The salary you receive as an employee of the S Corporation is reported on your personal income tax return. If you’re a shareholder-employee, you’ll likely file Form 1040 (U.S. Individual Income Tax Return) and include the information from your Form W-2.

Schedule E

Depending on your specific situation, you might also need to complete Schedule E (Supplemental Income and Loss) of your Form 1040. This schedule is used to report income or loss from rental real estate, royalties, partnerships, S Corporations, and more.

Social Security and Medicare Taxes

The salary you receive from the S Corporation is subject to Social Security and Medicare taxes, often referred to as FICA taxes. [1] However, as an S Corporation shareholder-employee, you are responsible for paying both the employee and employer portions of these taxes. [2] It’s important to note that in the case of the employer portion, it is typically covered by the S Corporation itself. This is in contrast to traditional employees, where the employer typically bears the responsibility for the employer portion of these taxes.

Estimated Taxes

Since the S Corp doesn’t withhold taxes from your salary, you’ll need to make estimated tax payments to cover your own income tax liability. [3] Estimated tax payments are typically made quarterly to the IRS.

Ensuring Compliance and Documentation

the business man passes a check across his desk to an employee or shareholder, demonstrating how to pay yourself as an s corp

It’s essential to keep thorough and accurate records of your salary, distributions, and any other financial transactions related to the S Corporation. These records will be important in case of an IRS audit or any questions about your tax filings.

Remember that the IRS has specific guidelines to prevent S Corp shareholders from avoiding payroll taxes by taking excessive distributions in place of reasonable salaries. It’s essential to strike the right balance between salary and distributions to ensure compliance with tax regulations while also appropriately compensating yourself for your role in the business. It’s also important to stay up-to-date and consult with professionals who can provide you with personalized advice based on your unique situation.

If you’re not sure whether your S Corporation compensation would pass IRS muster, RCReports can help. We collect data from a broad variety of sources to make sure you’re getting the most comprehensive information possible. Make sure your business decisions are informed ones—book a demo today to see what RCReports can do for you.

References

1. Internal Revenue service. (2023, July 27). Paying Yourself

https://www.irs.gov/businesses/small-businesses-self-employed/paying-yourself 

You will be liable for social security and Medicare taxes and withheld income tax if you do not deduct and withhold them because you treat an employee as a nonemployee, including yourself if you are a corporate officer, and you may be liable for a trust fund recovery penalty.”

2. Kitces, M. (2016). How An S Corporation Reduces FICA Self-Employment Taxes. 

Nerd’s Eye View | Kitces.com. https://www.kitces.com/blog/s-corporation-to-reduce-self-employment-taxes-and-social-security-fica/ 

“Similarly, when an owner-employee of an S corporation receives a salary payment (i.e., for services rendered to the business), the payment is deductible to the business, and taxable to the owner-employee. The net result is substantively the same as an S corporation dividend – the income is only taxed once, to the owner-employee.

An important distinction, however, is that while both the pass-through income of an S corporation, and a salary payment from an S corporation, are ultimately taxable to the owner-employee, at ordinary income rates, their treatment is not identical. Because as “corporate” income, an S corporation’s pass-through income by default is not subject to employment taxes under Revenue Ruling 59-221, since it was not directly earned (even though it’s otherwise treated as ordinary income). By contrast, a salary payment is fully subject to FICA taxes.”

3. Internal Revenue Service. (2023b, March 21). Estimated Taxes

https://www.irs.gov/businesses/small-businesses-self-employed/estimated-taxes

“Taxes must be paid as you earn or receive income during the year, either through withholding or estimated tax payments. If the amount of income tax withheld from your salary or pension is not enough, or if you receive income such as interest, dividends, alimony, self-employment income, capital gains, prizes and awards, you may have to make estimated tax payments. If you are in business for yourself, you generally need to make estimated tax payments. Estimated tax is used to pay not only income tax, but other taxes such as self-employment tax and alternative minimum tax.”

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