If your business is set up as an S-Corp (or an LLC with an S-Election), you are technically both an employee and a shareholder. Which means you should be paying yourself a salary as an employee, but you’re also able to accept distributions as a shareholder, easing a bit of the employment tax burden. (That’s one of the benefits of filing as an S-Corp, after all!)
Paying a Salary
As an employee who provides substantial services to your business, you must pay yourself a reasonable salary. Now, the topic of reasonable compensation is much debated. Reasonable compensation can look very different for every person and every S-Corp. But the important thing is to consider how the IRS will view your role and reasonable compensation. A good rule of thumb is to pay yourself at least the average salary for the job that you perform within your business. (You can find that information in the Bureau of Labor Statistics salary database).
Keep in mind that paying yourself a salary means setting up payroll, filing quarterly payroll reports and paying payroll taxes at all governmental levels. The good news is that paying quarterly payroll taxes means you’re avoiding the dreaded self-employment tax problem – the bad news is that the penalties for missing payroll tax deadlines are steep. So make sure you’ve hired an experienced bookkeeper to help you sort through the payroll tax waters.
Now, here’s the best part of setting your business up as an S-Corp: you can take distributions that aren’t subject to employment tax. That’s the benefit of being a shareholder! You can take these distributions at any time – simply pay them to yourself and label them accordingly. Do keep in mind that while you can take distributions at any time, there are other factors to consider. Distributions can get a little tricky, so this is another situation where your accountant can help you make the best choice for you and your business.
Find the right ratio
There is no perfect ratio to follow to make sure you are within “reasonable” limits. What is right one year may change the next. It will vary based on whether you are a managing partner or have a smaller role. It will vary based on the business’s income level, changing economic situations, and many other things. Finding the right ratio is a delicate balancing act that must be done every year.
Deb Howard Greenleaf, EA, CEO and Principal, of Greenleaf Accounting Services provides virtual accounting and bookkeeping services and specializes in financial management to consultants, coaches, solo professionals, and other small business owners across the US. Deb is an Enrolled Agent (EA)—an IRS-licensed tax professional—and specializes in small businesses and entrepreneurs filing Schedule C or as an LLC. As an Advanced Certified QuickBooks ProAdvisor, Deb spends her day in QuickBooks Online and specializes in providing QBO support.