What You Need To Know About S-Corps: Payroll and Reasonable Salary
If you've chosen to incorporate as an S Corporation (S-Corp) instead of as a sole proprietor, you were likely enticed by the tax savings available to S-Corps—and that makes complete sense. S-Corps are pass-through entities that save you from paying corporate taxes.
However, to comply with IRS regulations, there are some things you need to know about S-Corps and how they work.
We'll start with payroll. S-Corp owners are required to collect what the IRS refers to as a "reasonable salary," as well as "distributions." But, what exactly does that mean and what tax implications does it have?
What is a "Reasonable Salary”?
In very basic terms, a reasonable salary is one that aligns with what you might make doing the same job elsewhere. You might know this number already if you've had a similar role in the past, or you might need assistance identifying your current reasonable salary.
Some factors the IRS considers when determining a reasonable salary may include:
The level of training or years of experience required for the role
Amounts taken as distributions vs salary for that tax year
How much time was spent on the business
What other similar businesses pay for the same job title
…and more
You must pay payroll taxes on your salary, which is a 15.3% tax that contributes to Medicare and Social Security.
Don't know where to begin determining what a reasonable salary for your role would be? At Modis Advisors, we conduct reasonable salary research as part of our payroll service, taking into account your unique situation and all relevant information. That ensures you're receiving (and reporting) a salary that's fair and appropriate and complying with IRS requirements.
What is a "Distribution?"
Beyond your reasonable salary, you can also take distributions. Distributions from your company's profits are made to you and do not count as your salary or self-employment income. Unlike your salary, you do not have to pay payroll taxes on distributions.
You can see now why the IRS wants you to take a reasonable salary; otherwise, if every S-Corp owner only took distributions, there would be no way for the government to collect payroll taxes!
It's important to play by the rules here; evading taxes by playing with distributions and reasonable salaries can lead to huge penalties. As part of some of our packages, we assist clients with figuring out what should be a distribution and what should be part of their salary.
What If I Don't Make Enough To Pay a Reasonable Salary?
If you know what a reasonable salary is for your job but are not currently bringing in enough to pay yourself that, just make sure you aren't taking distributions as your compensation. Because every situation is unique, it is best to consult with your tax advisors to be sure you're in the clear, as many factors can impact your situation.
Ready to learn more? The team at Modis Advisors is here to answer any questions you might have about S-Corps, how to file your taxes correctly, or any tax planning matters at all.
Reach out to us today to start a conversation.