AUG 23, 2024
Calculating payroll for an S Corporation, aka an “S-Corp,” can be confusing. As you work out the best plan and organizational structure for your business, you may have questions about how your chosen business entity will affect payroll. There are valuable benefits to becoming an S-Corp, but also complex payroll regulations. In this blog, we’ll look at the answers to some of the top questions about S-Corp payroll and how a payroll outsourcing provider like Payroll Vault Walnut Creek can help make managing your payroll easier.
WHAT IS AN S-CORP?
An S-Corp is a business/corporation that’s elected to pass all its corporate income, losses, credits, and deduction to its shareholders for inclusion on their personal income tax forms, so long as the shareholders meet the IRS’s S-Corp eligibility requirements. One advantage of owning an S-Corp is it gets limited liability protection, regardless of its tax status, so your personal assets are generally shielded from business creditor claims. However, whenever claims arise, it’s still recommended you consult your business attorney for details.
S-Corps also enjoy the benefits of incorporation without double taxation. Shareholders pay personal income taxes on their pass-through earnings, but the corporation doesn’t. Lastly, shareholder profits and related distributions aren’t subject to Medicare or social security (FICA) taxes.
Many S-Corp shareholders perform a double function as shareholder-employees of the S-Corp. These shareholders must receive a salary and pay relevant taxes. As a result, S-Corp payroll needs to incorporate reliable solutions for managing shareholder-employee payroll.
HOW DOES S-CORP PAYROLL WORK?
Due to some of the preferable tax benefits of an S-Corp, many entrepreneurs find S-Corps an appealing way to structure their business. According to a Sept. 2022 report from small business financing company Guidant Financial, there are over 5 million S-Corps in the U.S. However, these benefits are dependent on correctly processing payroll.
S-Corps, like many other businesses, run payroll by calculating taxes based on wages earned in a pay period. Consistency is important; payroll needs to be done on a regular schedule, such as weekly, bi-weekly, or monthly. Additionally, S-Corps may issue bonuses or reduce shareholder-employee compensation based on business success and projected profits.
HOW DO S-CORP OWNERS PAY THEMSELVES?
S-Corp shareholder-employees typically pay themselves via salary and distributions. The salary is required if a shareholder performs anything more than minor or occasional services for the company. As the business grows, shareholder-employees must earn a salary comparable to what other businesses pay employees for the same type of work.
When setting shareholder-employee salaries, they must be reasonable in accordance with IRS requirements. Factors for determining a reasonable salary include:
- Work performed.
- Available cash for shareholder payroll/distribution.
- Timing of payments.
- Business operations (if other employees contribute to business success).
Regular payroll reviews based on business success are recommended to ensure shareholder-employee payroll remains reasonable.
Once a salary level is determined and deemed reasonable within IRS requirements, S-Corp owners divide the annual figure by the pay periods, and determines how much should be withheld for various taxes, including:
- Payroll taxes.
- FICA taxes.
- Unemployment taxes.
- Any other related business payroll taxes.
Any profit made above the shareholder-employees’ regular payroll can be distributed to the shareholders’ personal accounts. To avoid added IRS audit risk, it’s often recommended making distributions less frequent than the shareholder-employee payroll, such as making distributions on a quarterly or annual basis; consulting with your tax professional is recommended. No payroll taxes are withheld or paid on distributions made to shareholders; these distributions are the result of profits that’re taxed to the shareholder when they file their personal income tax return, free of the payroll related taxes. For accounting and record-keeping purposes, S-Corp payments to the shareholder-employee as an employee are shareholder payroll expenses; shareholder distributions are recorded as an equity distribution of profit.
Salary and the pass-through profits add up to your total income while owning an S-Corp. But because the planning, calculations and reporting for payroll taxes can be complex, it is advisable to outsource the shareholder-employee payroll function to a trusted payroll outsourcing company like Payroll Vault Walnut Creek, which will work with your other professionals and help you navigate the payroll process.
HOW CAN PAYROLL VAULT SUPPORT YOUR S-CORP PAYROLL NEEDS?
We understand handling payroll in-house can be challenging, even for an S-Corp owners with one or just a few employees. We’re proud to offer you payroll and additional human resources solutions tailor fit to your needs. Our boutique payroll service is uniquely qualified to address the needs of companies that seek solutions that can free them up to handle their business operations. We focus on cutting-edge technology and efficiency, serving as an industry leader dedicated to helping our clients succeed. Visit your nearest Payroll Vault location or if you're in the area, visit our Payroll Vault Walnut Creek office today to learn more.
