How to pay yourself from an S Corp
Paying yourself from an S Corporation (S Corp) can be confusing for many business owners. Unlike a sole proprietorship or a partnership, where you simply take money out as needed, an S Corp requires a more structured approach. Understanding how to pay yourself correctly helps you stay compliant with tax laws and avoid costly penalties. This guide explains the key steps and best practices for paying yourself from an S Corp.
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Understanding the Basics of an S Corp
An S Corp is a special type of corporation that allows profits and losses to pass through to shareholders’ personal tax returns. This avoids the double taxation faced by traditional C Corporations. However, the IRS requires that S Corp owners who work for the company pay themselves a reasonable salary before taking any additional profits as distributions.
What is a Reasonable Salary?
A reasonable salary is the amount you would pay someone else to do your job. It should reflect your role, experience, and the industry standard. Paying yourself too little can trigger IRS audits and penalties, while paying too much reduces the tax benefits of the S Corp structure.
For example, if you run a small marketing consulting firm, and the average salary for a consultant with your experience is $70,000, that’s a good benchmark for your reasonable salary.
Steps to Pay Yourself from an S Corp
1. Set Up Payroll
You must run payroll for yourself as an employee of the S Corp. This means withholding income taxes, Social Security, and Medicare taxes just like any other employee. Many small business owners use payroll services such as Gusto, ADP, or QuickBooks Payroll to simplify this process.
2. Determine Your Salary
Research salaries for your position using resources like the Bureau of Labor Statistics or salary websites such as Glassdoor. Set your salary based on this data and document your reasoning in case of an IRS review.
3. Pay Yourself Regularly
Pay yourself a consistent salary, typically on a biweekly or monthly basis. This helps maintain clear records and shows the IRS that you are treating your compensation properly.
4. Take Additional Distributions
After paying yourself a reasonable salary, you can take additional money out of the business as distributions. These distributions are not subject to payroll taxes, which can save you money. However, distributions should not exceed the company’s profits.
5. Keep Accurate Records
Maintain detailed records of all payroll payments and distributions. This includes pay stubs, bank statements, and corporate minutes documenting salary decisions. Good record-keeping protects you during tax audits.
Example Scenario
Imagine you own an S Corp that provides graphic design services. You determine that a reasonable salary for your role is $60,000 per year. You set up payroll and pay yourself $5,000 per month. The company earns $100,000 in profit for the year. After paying your salary, you take the remaining $40,000 as a distribution.
This approach ensures you comply with IRS rules while maximizing tax savings.
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Tax Implications of Paying Yourself from an S Corp
Payroll Taxes
Your salary is subject to payroll taxes, including Social Security and Medicare. The S Corp must also pay the employer portion of these taxes. This is why setting a reasonable salary is important — it balances tax savings with compliance.
Income Taxes
Both your salary and distributions flow through to your personal tax return. Salary is taxed as ordinary income, while distributions are generally not subject to self-employment tax. This can reduce your overall tax burden.
Avoiding IRS Red Flags
The IRS pays close attention to S Corps that pay little or no salary to owners but take large distributions. This can trigger audits and penalties. Always document how you determined your salary and keep payroll records up to date.
Tools and Resources to Help
Payroll Services: Gusto, ADP, QuickBooks Payroll
Salary Research: Bureau of Labor Statistics, Glassdoor, Payscale
Accounting Software: QuickBooks, Xero
Using these tools can simplify paying yourself and managing your S Corp finances.
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Final Thoughts on Paying Yourself from an S Corp
Paying yourself from an S Corp requires careful planning and documentation. Start by setting a reasonable salary based on your role and industry standards. Use payroll services to handle tax withholdings and pay yourself regularly. After covering your salary, take additional profits as distributions to benefit from tax savings.
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