S corporation owners have an advantage when it comes to paying estimated taxes. In most cases, shareholder/employees can withhold enough from each paycheck and not have to worry about quarterly payments.
Disclaimer: S corporation taxes and estimated tax planning are complicated issues. Mistakes can lead to penalties and stressful unexpected tax balances. We strongly recommend you seek out the help of a tax professional who specializes in s corporations. Don’t blame us – we tried to tell you.
Quarterly estimated taxes for the self employed
If you are operating as an s corporation, I hope you already know that taxes are “pay as you go”, not “pay at the end of the year”.
If you do not make at least quarterly estimated tax payments to cover the net profit from your s corp, you will get hit with penalties and an unpleasant tax balance at tax time.
S corporation reasonable salary requirements
I’m sure you also know that as an s corporation owner who provides more than minimal services for your s corp, that you must run payroll and pay yourself a reasonable salary. This is for the work that you provide for your business.
If you don’t, you could face some very unpleasant multi-year self employment tax assessments. These IRS corrections are miserable. So if you don’t, you better look that up.
S corporation shareholders can withhold extra from salary to cover all income taxes
OK, so we are up to date on paying quarterly estimated and running payroll. Of course.
What many s corporation owners do (and what I do), is to take extra withholding from each salary paycheck to cover the net profit as well as the salary.
Here’s an example. Stay with me here – it’s easy.
Let’s say that an s corporation pays it’s owner $65,000 and makes $35,000 in net profit. This $35,000 is probably taken as a distribution – but that doesn’t matter so much. The s corp shareholders still need to pay income tax on the net profit.
So with normal payroll withholding, income tax on the $65,000 is covered – but what about the $35,000?
Well, we can make estimated tax on that. Or, better yet, we an withhold additional amounts for each paycheck to cover the taxes on the $35,000 net profit.
Figuring the estimated tax for your s corp profits
How much should we take out? Well that should be calculated with software, preferably. But if you don’t have software, I have a rule of thumb for you.
Now don’t hold me to this, because your estimated income tax liability can depend on several dynamic factors, but 25% works pretty well for federal taxes.
There’s an old saying, “the government is a one third partner in all of your business activities”. And it’s true.
So why do I use 25%? It’s because you are already paying the social security and medicare taxes out of your check and with your payroll tax deposits. So this $35,000 is taxed at a lower rate.
20% might even be good enough, especially now-a-days with the qualified business deduction.
Don’t forget state income taxes, as applicable. You should have an idea of your state tax bracket.