If you’re an S-Corporation owner wondering how you get paid, then go ahead and shout, “Show me the money!”
In today’s post, I’ll break down the two ways S-Corporation owners get paid from their business.
How is an S-Corporation different from other types of businesses?
First of all, how you get paid as an S-Corporation owner can be different from how you have been paid in other positions because of the way this particular business structure works.
An S-Corporation business structure offers certain tax advantages to its owners. It works much like a regular corporation, but with a special tax status granted by the Internal Revenue Service (IRS).
The S-Corporation status allows the corporation’s income, losses, deductions, and credits to “pass through” to its shareholders, who then report these on their individual tax returns. As the owner, you’re entitled to a share of the company’s profits and benefits just like any other shareholder or employee. So, naturally, you’ll want to figure out how to get that compensation into your personal bank account.
How do S-Corporation owners get paid?
As an S corporation owner, you wear two hats: the owner hat and the employee hat. You’re not just sitting back and collecting profits; you’re actively contributing to the company’s success. This dual role is what shapes the two different ways you can get paid:
Employee Salary: The first way an S-Corporation owner gets paid is just like at any other job: you earn a regular paycheck. This is your employee salary, and it can be paid through a check, bank transfer, or direct deposit.
However, before writing that first check to yourself, you’ll need to determine how much to pay yourself. The IRS calls this “reasonable compensation.” This is not a decision to take lightly. In fact, I’ve written a separate post that delves into how reasonable compensation should be determined in order to avoid problems with the IRS.
And don’t forget that your salary is subject to income tax, Social Security tax, and Medicare tax, just like any other employee.
Distributions: Now, here’s where things get interesting. As an owner, you also have the opportunity to receive shareholder distributions from the company’s profits. This is different from your salary because it’s generally not subject to Social Security or Medicare taxes as long as your distribution amount isn’t more than your stock basis.
However, keep in mind that while distributions can be tax-advantaged, they’re not guaranteed, and you should make sure your company is financially sound before taking distributions.
Can an S-Corporation owner get paid mostly in distributions?
I know what you’re thinking. Since distributions have tax advantages, you can just pay yourself a super low salary and take a bunch of distributions to dodge taxes, right? Here’s why that won’t fly: The IRS has its eye on this strategy, and they do not look kindly on anyone who tries to unfairly minimize their tax obligations.
Instead, it’s important to strike a reasonable balance between your salary and distributions. Some accountants have formulas they recommend, but honestly, the best way to make sure you’re not going to get in hot water with the IRS is to first figure out your reasonable compensation (salary) and then take distributions from your company’s profits at the end of the year.
What records does an S-Corporation owner need to keep when paying themselves?
To keep things legit and stay on the good side of the IRS, it’s crucial to have proper documentation and follow the rules. S-Corporation owners need to keep accurate records for:
Payroll: Keep detailed records of your pay stubs, tax withholdings, and any other relevant payroll documents. If you’re looking to make this step easy while also ensuring you don’t miss any paperwork or filings, then Gusto is the only payroll service I recommend to my clients. Not only do they take care of payroll, but they file all of the necessary forms for you, and they have top-notch customer service.
You may also have records and documents that you’ve used in determining your reasonable compensation. You should keep those too in case you ever need to prove to the IRS that you’re paying yourself a reasonable salary for the work you’re doing.
Distributions: Just like with your salary, maintain records of any distributions you receive. The records should clearly show that the distributions were taken as a share of the company’s profits at the end of the year.
There’s also a full list of tax-related paperwork you’ll need to file and keep.
What else do I need to know about how S-Corporation owners get paid?
A couple of other things S-Corporation owners should keep in mind is that it’s good to maintain consistency in payments. In other words, avoid making drastic changes to your salary without a valid reason, as this could raise suspicions.
Additionally, when determining your compensation, choosing your payroll system, or completing tax documentation or bookkeeping, it’s important to consult professionals that can guide you through the process and make sure you’re in compliance with all tax regulations. Don’t be afraid to ask for help, especially if you’re new to owning an S-Corporation.
In short, an S-Corporation owner gets paid through a combination of salary and distributions. Your salary is like a regular paycheck, subject to payroll taxes, while distributions come from the company’s profits and have tax advantages. Remember, it’s all about finding that sweet spot between reasonable salary and distributions, and staying on top of your tax responsibilities.
For more easy-to-digest information on all things S-Corp and taxes, explore some of my other articles: