How to Pay Yourself as an S Corp

If you own an S Corp and do not pay yourself correctly, then you are at risk of getting in trouble with the IRS.

The IRS may audit you and:

• Recharacterize your distributions as wages subject to payroll taxes
• Issue fines for failure to comply with S Corp rules
• Assess penalties and interest on the balance owed

In order to prevent that from happening, here are some ways on how to pay yourself as an S Corp.

S Corp Reasonable Compensation Requirement

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If you own an S Corporation and work in the business, the IRS requires you to pay yourself a reasonable W-2 salary first.

After paying this salary, you can take additional money from the business as owner distributions based on your shares.

The IRS requires this to ensure that payroll taxes, like Social Security and Medicare, are paid on your wages.

The good news is that after you meet the W-2 requirement, your owner distributions are not subject to payroll taxes, which can save you money.

What is a Reasonable Salary?

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As a general rule, you must set your compensation at a level that is “reasonable.” 

This means the salary should be similar to what other businesses pay for the same type of work and experience level in your industry and location.

To figure out a reasonable salary, consider these factors:

• Your qualifications and training for the role
• The number of years you have worked in the field
• The typical pay range for your job title and responsibilities in your local area
• Your business size and type
• Salaries of people in comparable roles at other companies
• The general cost of living in your city/region

The goal is to look at the typical pay for someone with your background doing similar work and set your salary in that reasonable range based on market rates. 

Paying yourself significantly more or less than the normal amount could raise red flags with the IRS.

Taking the time to justify your salary with data helps ensure you are complying with the “reasonable compensation” requirement for business owners.

How to Pay Your Reasonable Salary

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You must set up a payroll system to pay your reasonable salary as an S Corp.

You can easily accomplish this by signing up with a good payroll provider.

A good payroll provider will do three things for you at a minimum:

1. Pay your W-2 wages and calculate all payroll taxes on your behalf.
2. Withhold payroll taxes from your paychecks and pay them on your behalf.
3. File all payroll tax returns on your behalf and issue your W-2 at the end of the year.

To set this up, all you should do is purchase a payroll plan. The provider will guide you through some simple registration steps to get everything connected.

Most payroll plans cost around $40-60 per month, which is an insignificant cost compared to the tax benefits of using an S Corp.

Here are some discount links to some of our favorites:

• ADP (Get 20% Off): 
• Gusto (Get a $100 Gift Card): 
• QuickBooks Payroll (Get 30% Off): 

When to Back Pay Your Salary

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Once your payroll system is set up, you can proceed to pay yourself a W-2 salary.

If you are setting up payroll in the middle of the year, you can back pay yourself for wages missed earlier that year. 

There are several ways to accomplish this, but the easiest solution is to pay yourself a one-time bonus to back pay your reasonable compensation.

This allows you to submit a lump-sum payment within any date range. You can submit your entire salary for the whole year as a bonus or submit a bonus for the time period where wages were not submitted. 

The bottom line is that you should run the entire amount of your reasonable compensation through your payroll provider by the end of the year. That way, they can prepare your W-2.

This can also serve as evidence that you submitted your S Corp compensation for the year.

How to Pay Your Salary on an Ongoing Basis

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Once you have back-paid your wages through your s corp, you should establish a routine with how you will pay your wages going forward.

Some business owners prefer to wait until the end of the year to pay their reasonable compensation, which allows them to have more cash on hand for their business throughout the year.

If you decide to do that, you should use the back pay method similar to what we discussed in the last section.

Alternatively, you can set up weekly, biweekly, or monthly payroll cycles to pay yourself on an ongoing basis throughout the year.

As long as you don’t miss any payroll cycles, you should have paid yourself the exact amount of money that you planned on.

This means you should receive a W-2 that reflects your reasonable compensation in the following year, and you will be compliant with the IRS S Corp requirements.

How to Pay Owner Distributions

Once you can pay your reasonable salary, you can take owner distributions from the remaining profits as you wish.

You can withdraw funds directly from your business bank account and distribute them to your personal bank account.

A distribution is a payment made to shareholders, often in cash or stock, and is not subject to payroll taxes like Social Security and Medicare. 

Distributions offer more flexibility with your income because you can adjust your pay based on how well your company is doing. 

You would not pay taxes on these distributions unless they exceed your initial investment in the company, known as your stock basis.

For S corporations, the stock basis can change each year due to the company’s profits and losses. 

It’s crucial to keep track of your stock basis regularly to accurately report your share of the company’s profits and losses on your tax return.

Bottom Line

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Successfully operating an S Corporation requires diligent compliance with IRS regulations, especially when paying yourself properly. 

While it does involve some extra effort, it is well worth it to steer clear of the IRS’s watchful eye. 

My advice is to work with a professional and diligent CPA to guide you through the process.

By taking the right steps, you can enjoy the liability protections and tax benefits of an S Corp structure while sleeping soundly knowing you are complying with all the requirements. 

It is just one of those responsibilities that comes with being the boss!