S Corporation “S-Corp” payroll can be confusing for business owners. As entrepreneurs work out the best plan and organizational structure for their new business, there may be some questions on how the payroll function will be affected based on the business entity they’ve chosen. Many of them would benefit from becoming an S-Corp but aren’t aware of the full scope of regulations including S-Corp payroll. For those in that category, it’s essential to learn the answers to these top questions so you know how to handle some of the important and specific details correctly.
WHAT IS AN S-CORP?
An S-Corp is a type of business and a type of Corporation that has elected to pass all its corporate income, losses, credits, and deduction along to its shareholders to be include on their personal income tax forms, so long as the shareholders meet IRS eligibility requirements to be an S-Corp.
The advantages of an S-Corp start by providing owners limited liability protection, regardless of its tax status, meaning that personal assets are generally shielded from claims leveled by business creditors, whether the claims arise from contracts or litigation, it is recommended you discuss details with your business attorney. S-Corps also enjoy the benefits of incorporation without double taxation. Shareholders pay personal income taxes on their pass-through earnings, but the corporation as an entity does not. Furthermore, shareholder profits and related distributions aren’t subject to Medicare and social security (FICA) taxes. All important advantages to consider.
However, many S-Corp shareholders perform a double-function as a shareholder-employee of the S-Corp and therefore most earn a salary and are paid (and pay relevant payroll taxes) as such. As a result, S-Corps need reliable solutions for managing their 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. Taking full advantage of the benefits is dependent, however, on the business owner’s ability to determine and then process the S-Corp payroll correctly.
Much like other businesses that employ workers, S-Corps run payroll by calculating taxes based on wages earned during any given pay period. Consistency is also an important consideration because payroll needs to be done on a consistent and typical schedule, for example, weekly, bi-weekly, or monthly. Additionally, they may decide to issue bonuses or reduce the shareholder-employee compensation based on the success and related projected profits of the business.
HOW DO S-CORP OWNERS PAY THEMSELVES?
Those who are both shareholder and employee with an S-Corp typically pay themselves via salary and distributions. The salary is required if an individual performs anything more than minor or occasional services for the company as a shareholder. As the business grows and becomes profitable the S-Corp shareholder-employees must earn a salary that is comparable to what other businesses pay employees for the same type of work.
Once a salary level is determined, S-Corp owners divide the annual figure by the pay periods, providing a resulting withholding of payroll taxes, FICA taxes, and other related business payroll taxes like unemployment taxes. When considering a salary for the shareholder-employee it must be reasonable per IRS requirements. Several factors go into determining a reasonable salary, they not only include work performed but also include available cash for shareholder-payroll and shareholder-distribution, timing of payments and how the business operates and if other employees contribute to the success of the business. Reasonableness is the key and regular reviews are recommended based on the success of the business.
Any profit you make above your regular payroll can then be distributed to the shareholders personal accounts. To avoid added IRS audit risk, it is often recommended that distributions are less frequent than the shareholder-employee payroll and distributions be made on a quarterly or annual basis, consulting with your tax professional is recommended. No payroll taxes are withheld or paid as a result of distributions made to the shareholder, these distributions are the result of profits that are 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 and 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 service company that will work with your other professionals and help you navigate the S-Corp payroll process.
HOW CAN PAYROLL VAULT SUPPORT YOUR S-CORP PAYROLL NEEDS?
Payroll Vault understands that handling payroll needs in-house can be challenging, even for an S-Corp owners with 1 or just a few employees. Payroll Vault provides payroll and additional human resources solutions for all types of small and medium-sized businesses and tailor fits our services to your specific needs. A boutique payroll service business founded in 2008, we are uniquely qualified to address the needs of companies that seek solutions that can free them up to handle their business operations.
Focused on cutting edge technology and efficiency, Payroll Vault serves as an industry leader dedicated to helping our clients succeed in business.
Learn more about how Payroll Vault - Western Michigan can serve your business and get a quote from today.