Jovan Johnson, MBA, CFP®, CPA/PFS

 

Many small business owners opt to elect S Corporation (S Corp) tax status over a sole proprietorship due to potential self-employment tax savings. However, to fully leverage these benefits, it is crucial to understand the specific requirements for paying yourself as an S Corp owner.

Unlike sole proprietorships, where paying yourself is straightforward, S Corps introduces some complexity. This article will explore the various ways to pay yourself as an S Corp owner.

How to Pay Yourself as an S Corp Owner

There are three primary ways to pay yourself as an S Corp owner: salary, distributions, or a combination of the two. The best approach depends on your role within the S Corp. For this article, we will assume you are both the owner and an employee of the S Corp. This will require you to pay yourself a reasonable salary, with any remaining profits potentially distributed as dividends. In the next section, we will cover the salary and distribution payment methods.

Salary

This payment method is the most complex way to pay yourself as an S Corp owner. Since you are both the owner and an employee of your company, the IRS requires you to pay yourself a salary. Additionally, the IRS requires that this salary is “reasonable” based on your role in the business. 

See the image below for some factors to consider when determining reasonable compensation according to the IRS:

How to Pay Yourself as an S Corp

Not sure where to start? Base your salary on industry statistics to ensure it aligns with what others in similar roles are paid. Here are some resources to help you find this information:

To pay yourself a salary from your S Corp, you will need to run payroll via a payroll provider like Gusto. These providers will handle your annual salary through payroll, ensuring the necessary taxes are withheld from each paycheck. The frequency of your paychecks will depend on your personal preference and specific state laws.

Additionally, you will need to pay both income taxes (federal, state, and local) and self-employment taxes on your salary income. You will remit these taxes to the IRS and your state/local government with each paycheck. At the beginning of the following year, you will receive a W-2 to report your salary income and taxes withheld on your Individual Income Tax Return (Form 1040) during tax time.

Shareholder Distributions 

Take any additional profit in the business as distributions after paying yourself a reasonable salary. This method simplifies the process compared to paying a salary. You can easily transfer funds from your business account to your personal account and label the transaction as a shareholder distribution.

One of the main advantages of electing S Corp tax status is that distributions come with a lower tax bill. Distributions are not subject to self-employment taxes, only income taxes, as long as your salary meets reasonable compensation requirements. However, if you don’t follow these rules, the IRS may reclassify your distribution as salary income (more taxes).

Remember to pay quarterly estimated taxes to the IRS and state/local agencies on your profits after deducting business expenses and your salary. You typically report these profits on Schedule E, which you attach to your Individual Income Tax Return (Form 1040).

Other Things to Consider 

As an S Corp owner, there are additional complexities you need to be aware of including: 

  • Potential limitations on the Qualified Business Income (QBI) deduction
  • Social Security wage base limits on tax savings
  • Costs associated with payroll providers
  • Costs of additional tax return filings
  • Federal and State unemployment insurance taxes (FUTA and SUTA)
  • Potential State Franchise Taxes
  • Some states don’t recognize S Corp status

If you are interested in learning more about electing S Corp vs. Sole Proprietorship tax status, feel free to read one of our previous articles. 

Final Thoughts

Mistakes in handling paying yourself as an S Corp owner can lead to costly penalties and interest. Additionally, rectifying incorrect S Corp payments can be an accounting headache. Before electing S Corp tax status, it is wise to consult with a CPA to fully understand the requirements and ensure you are paying yourself correctly as an S Corp owner.

Would you like to learn more about how to pay yourself correctly as an S Corp owner? If so, please feel free to book a free consultation with us. 

Disclosures

None of the information provided is intended as investment, tax, accounting, or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement, of any company, security, fund, or other securities or non-securities offering. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information is at your sole risk. The content is provided ‘as is’ and without warranties, either expressed or implied. Piece of Wealth Planning LLC does not promise or guarantee any income or particular result from your use of the information contained herein.