When set-up correctly, filing as an S-Corp can have numerous financial benefits (read: saving that $$$). The biggest hurdle to safely maximizing tax savings through an S-Corporation is setting-up and managing payroll.
The whole spiel of S-Corps is that they help to shield the business and business owner(s) from overpaying on self-employment taxes by taking back control through payroll. Instead of 100% of the profits being subject to self-employment tax, the business instead puts the owner(s) on payroll and pays in their fair share of self-employment tax through wages. Read the basics about S-Corp’s here.
Steps to Set-Up Payroll for an S-Corp
The first step is having your business set-up as a bona fide employer. To do this, you’ll need to:
- Get registered as an employer with your state – this process varies depending on where you live, but typically only requires some minor paperwork that we are happy to help you with. (If you’d rather DIY: Google “Gusto + Your State’s Name + Payroll Set-Up” – Gusto has incredible resources for each state).
- Once you’ve made it official with the state, set-up and use a payroll software like Gusto to ensure that everything is happening correctly. Gusto makes it disgustingly simple to set-up, manage and stay compliant with running payroll for yourself. If you use our link, we’ll both receive a $100 Amazon gift card after you run your first payroll. 🙂
- Pro Tip: You can (and should!) take it a step further by setting-up a 401k using Guideline401k. Guideline syncs directly with Gusto and it’s aaaaaaaamazing.
How Do S-Corp Owner’s Actually Get Paid?
Most S-Corp owners will receive funds from their business in two ways – through payroll and through distributions.
Now’s where things get serious – as the proud owner of an S-Corporation, you should be paying yourself a reasonable and consistent salary. No more randomly cut checks, miscellaneous transfers, general commotion, or [cough] using the business credit card for personal expenses [cough].
What’s reasonable? Well, that’s the million dollar question. It’s definitely a bit of a gray area, and it seems like most tax professionals have differing opinions on this. A few things to take into consideration when determining what to pay yourself include:
- What other people in similar positions are making
- Your cost of living
- The volume of your business
- The level of skill needed to do your job
- How much time you are spending in and on the business
- What others in your company are making
- Your pay in comparison to the profits of the business
- How much you are taking in distributions from the business
All things being equal, you should be paying yourself as much as you’d earn doing what you do for someone else. As the IRS puts it, you should be paying yourself “the amount that a similar company would pay for the same or similar services.” You’ll want to work with your CPA to ensure you’re paying yourself a reasonable salary. You can also generate a fancy Reasonable Compensation report yourself here.
Still confused? We get it. Let us break it down for ya real simply: Just don’t be a dick. Pigs get fed, hogs get slaughtered. If you’re out there trying to scam the IRS on self-employment tax, it’ll catch up to you – either through an audit (back taxes, penalties, etc.), or through a measly social security payment (if you don’t pay self-employment tax, you don’t pay social security, and if you don’t pay social security you don’t receive social security), or through not being able to get unemployment during a pandemic, etc.
Come at it correct – pay yourself what you’re worth without spending unnecessary money in taxes (instead keep that money to grow wealth and sustainability in your business), and have good intentions.
Now that we’ve gotten that out of the way, let’s talk distributions. It’s likely that the salary you’re going to be putting yourself on is going to be less than the total monies you are used to taking from the business – this is okay, normal and expected. You will be made whole through distributions.
You are used to taking a draw of $5,000 each month from the business prior to becoming an S-Corporation. After forming the S-Corp, you now will take a salary of $3,000 per month and set-up a recurring transfer to yourself for the difference of $2,000 each month. Your bottom line number did not change, you just shifted the allocation.
Make sure you pay yourself consistently and fairly in order to properly maintain your S-Corp designation. Utilizing a great software (like Gusto!) can automate the entire process, making it simple (and fun!) for you to pay yourself as an S-Corp. In addition to payroll, shareholders can also receive funds in the form of distributions. These distributions are not subject to self-employment tax.
Please reach out, we’d love to help!
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Countless assumes no liability for actions taken in reliance upon the information contained herein.