I’m going to keep it extra simple in this post.
The IRS says that s corporation owners providing services for the s corporation are considered employees and must pay themselves a reasonable salary.
Disclaimer: S Corporation taxes and payroll are complicated. We strongly recommend that you seek consultation for managing your s corporation and payroll. Mistakes in with s corps and payroll can lead to multiple years of IRS disallowance and penalties. It’s really a nightmare – get help.
S corporation – How much payroll is reasonable?
If you are a shareholder of an s corporation and you provide more than minimal services for the business, then you must run payroll.
Note that if the s corporation is not profitable and there are no distributions to take, then running payroll might not be necessary.
Why s corporation owners must run payroll
What the IRS is really after here is “self employment tax” which is the same as “Social Security and Medicare” taxes.
Income from employment, sole proprietor income, and other earned income are all subject to these taxes. The IRS does not want you to avoid these taxes because it is against the intent of tax policy.
Sure, if you are earning income as a corporate shareholder or passive investor, then these social taxes are not appropriate. But if you are “laboring” and earning income by working for it, then you should be participating in these programs and paying these taxes.
If you don’t run payroll and you provide services for your s corporation, the IRS will likely come after you for several years of these taxes along with late penalties. So be sure to run payroll as appropriate to avoid such an unpleasant action.
How much payroll is reasonable?
The term reasonable is argumentative, of course.
Generally, the question I ask my clients is, “how much would it cost to replace your labor”?
When I ask this, I’m not talking about the time you spend doing things that business owners do, I’m talking about when you do the labor that an employee would do. This could include management tasks as well.
In my opinion, one of the best ways to figure out this amount would be to check out websites like payscale.com. There are more simple options like checking the local or online classifieds to see what employers are offering.
If you want to get complex about it, there are firms that will run an in depth analysis of the work you do and assign a value to it.
I’m not really sure that it is necessary to have a firm tell you how much your should pay yourself for your labor, but the cool thing about these places is that their methods have been accepted by the tax court on many occasions. If you take this route, you will pretty much KNOW that you are paying a correct amount or that you are not too far off.
How much do you think is reasonable to pay yourself? Please leave a comment.