How to Make Money as an S Corporation
For instance, you can be subject to IRS inspection, fines, penalties, and interest if you accept a salary that is too low or don’t receive one at all.
An S corporation gives firm owners three options for how to pay themselves. Salary, distributions, or a combination of the two. The greatest alternative for you will depend significantly on how much you contribute to the firm and how profitable it is. Let’s look more closely.
Why Do S Corp Payment Mechanisms Differ From Those of Other Business Entities?
The distinct payment structure of an S corporation enables firms to protect themselves from responsibility and maximize tax advantages.
To put it another way, unlike in a partnership or sole proprietorship, an S corp owner and stockholders aren’t personally liable for the business’s debts.
Numerous tax advantages come with filing as an S company. One benefit of incorporation is the avoidance of the double taxes associated with C corporations.
Similar to a partnership or an LLC, business profits and losses in an S corp are distributed to the shareholders. As a result, corporate tax is not applied to business revenues; rather, shareholders must pay taxes on those profits when they file their income taxes.
S corporations only pay self-employment taxes on their salary, but the owners of sole proprietorships, LLCs, and partnerships pay self-employment taxes on their whole firm profits. The S corp structure is one of small business owners favorites. Since these payouts are not subject to self-employment tax.
There is a hitch, in case you’re wondering why S corp owners don’t just take zero pay to completely escape self-employment taxes. The IRS mandates that you pay yourself a “reasonable salary”. Before making a tax-free distribution to yourself if you are a shareholder and an employee of a company, which most small business shareholders are.
What Is the Best Business Structure for You?
What is a “fair salary“?
It is generally accepted that your compensation should be “fair” when setting it. According to the IRS, reasonable pay is “an amount typically given for similar services by comparable firms under comparable conditions.”
When selecting a wage that is both comfortable for you and acceptable to the IRS, keep the following things in mind:
- Your education and training background, your years of experience, your field of expertise. The size and nature of your company, the wages of those in comparable positions, your industry, and more. Location and living expenses
- All of this means that you should conduct a thorough study before attempting to calculate your pay. You can find the correct figure for you with the aid of industry statistics and a variety of tools.
- You have three options for payment: salary, distributions, or both
The shareholders and employees of an S corporation are the same people. Your function has a direct impact on your compensation in an S corp structure. There are three ways to get your salary:
- A person’s wage
- Investor distributions
- A cross between the two
Option 1: Pay yourself a salary like an employee.
If you work for your company in an employee-like capacity, you must be paid a W-2 salary that enables you to correctly file and pay employment taxes. Whether or whether you get shareholder remuneration, such as distributions, this is an IRS requirement.
The benefits of paying yourself a fixed wage are numerous. As opposed to pulling money out of the business account whenever you need it, you know exactly how much of the company’s money is paid to you each month. This makes keeping track of costs and managing cash flow simpler. Earning a salary yourself demonstrates a consistent source of revenue.
Having this in mind, the IRS mandates that S corp employees be paid a fair wage. One that is comparable to the salary provided by enterprises with similar expertise. But not so low as to allow you to avoid paying certain taxes.
The S corp owners could face fines for failing to withhold and pay employment taxes. As well as past taxes owed if the IRS finds that a shareholder’s compensation does not qualify as “reasonable compensation” status.
Option 2: Pay yourself dividends from shareholders
If you don’t participate in the day-to-day operations of your business and don’t work for the S corp, you can take a salary out of the firm instead of using shareholder distributions.
A distribution is a payment of earnings to shareholders that is taxed at the shareholder level and is typically made in the form of cash or stock. Distributions are not subject to payroll taxes, employment taxes, social security taxes, or medicare taxes, in contrast to a wage. The shareholder’s individual income tax return is where they get taxed instead.
Taking distributions has the advantage of giving you more wage flexibility, enabling you to change your pay in response to your company’s performance. Shareholder distributions are tax-free until you exceed your stock basis or the amount you initially put into the company. If you exceed that amount, you must make a payment.
The stock basis of an S corporation might change often due to profits and losses in the company’s operations. Unlike the stock basis of a C corporation, which is different each year.
To accurately report your distributive shares of profit and loss on your income tax returns, you must frequently track your stock basis.
Option 3: Make salaries and payouts to yourself.
As long as your salary is commensurate with the labor you are performing, an owner and shareholder-employee may pay themselves using a combination of dividends and wages. The tax burden on additional gains can be smaller by taking them as dividends.
As long as your compensation complies with the standards for a reasonable salary, distributions are exempt from employment taxes. The IRS, however, has the right to categorize additional payments as taxable income if you don’t abide by the regulations.
How to Get Help from Your Part Time Accountant
We can manage your bookkeeping and tax filing for you as the largest professional bookkeeping service. All of this, while you concentrate on your company.
If you form (or switch to) an S company and don’t know how to manage to pay yourself, you can end up with bookkeeping errors that cause worse tax issues down the road. Our bookkeeping staff will keep your financials current. So that you can make decisions that are well-informed and adhere to any new regulations.
We’ll explain to you what a structural change means for your company. And make sure your records are up to IRS standards. When you add our tax filing solution, you get an all-star staff to prepare and file your tax return. As well as year-round tax advising help.