Benefits of Payroll for S-Corps
Filings as an S-Corp provide a number of benefits to business owners and business partners, including asset protection, avoidance of double taxation, improved distribution of federal tax liability, and significant self-employment tax savings.
Let’s explore the upsides of each benefit:
With S Corp status, business owners and business partners can protect their personal assets from any litigation/legal penalties the business may face.
Bypassing Double Taxation
S Corp shareholders report the flow-through income, losses, and credits passed to them via the S Corp and pay individual income tax on their personal tax returns. As a result, an S corporation is spared double taxation on all corporate income.
Payroll Tax Breaks
An S Corp is only obligated to pay FICA payroll tax on its employment wages, while the rest of the corporate profits are exempt from self-employment tax as well as FICA payroll taxes. Only income tax is required for any corporate profits. This is significant when considering FICA-taxable salary vs. profits. For instance, if a single-owner S corporation makes a total of $100,000 in earnings, and $45,000 is set aside for salary (FICA-taxable at 15.3%), the remaining $55,000 is only subject to income tax.
Choosing the Right S-Corp Payroll Solution: Factors to Consider
Even with all of these advantages available to S corporations, it can be a challenge for businesses to properly navigate payroll management to gain the most from potential tax benefits and other legal allowances.
1. List of Responsibilities
An S Corp is responsible for the following and more as it relates to payroll and taxes:
- Establishing a fair salary and distributions for any business owner(s), partner(s), or shareholder(s)
- Calculating income, unemployment, FICA taxes, and payroll
- Accurately recording all payroll transactions
- Filing local, state, and federal payroll taxes
- Preparing and submitting annual tax returns
- Tax payments on qualifying built-in gains and passive income earned as a business entity
2. Salary and Distributions
When switching to an S-Corp payroll, it’s critical to properly determine how to pay yourself and fellow shareholders. Technically, any S-Corp owner who participates in daily business operations is a shareholder and employee.
While owners who do not manage or participate in daily operations are only considered shareholders, the former category of the owner must collect earnings either through an employee salary, shareholder distributions, or a combination of the two.
With an employee salary or combined salary-distribution approach, you are required to create, receive, and report a W-2 that includes your yearly salary and any necessary employment taxes. The IRS requires that any S-Corp employee receives compensation that is on par with comparable roles in the same industry; failure to do so can result in IRS penalties.
As you work with a payroll provider to determine an appropriate salary that is aligned with your designated employee role, they should be able to help you formulate and archive documents that demonstrate how you reached your compensation number in the event of an IRS audit or inquiry.
Another option for owners who are also shareholder-employees is to earn compensation through a combination of salary and shareholder distributions. In this case, a W-2 and employment taxes are still required for reporting yearly salary, but distributions (cash or stock earnings, typically) are excluded from a variety of taxes, including payroll taxes, FICA taxes, and employment taxes.
Distributions are taxed on the individual income tax return of the shareholder. Bear in mind that if you plan to pay yourself partially or fully through distributions, you must be aware of your organization’s stock basis: the overall amount that you invested in the company. Any amount beyond that number is fully taxable income.
Regardless of which approach you choose for compensation, you will need the support of a qualified payroll provider to follow “reasonable salary” criteria articulated by the IRS, conduct third-party research on comparable salaries in your industry, and create a beneficial balance of salary and distributions that maximizes your compensation and potential tax breaks.
Following broad 50/50 or 60/40 salary-to-distribution ratios can give you a general idea of where to start, but it’s best to consult payroll experts about developing a strategy that works for your S Corp long-term and ensures adaptability in the face of changing regulations and business gains and losses.
3. What to Require from Payroll Services for Your S Corp
Fundamentally, the payroll provider you choose should be able to efficiently manage all of your payroll needs so you can shift focus towards core business tasks. Whether it’s establishing fair salaries, preventing payroll inaccuracies, completing tax calculations, determining pay frequency, or managing shareholder distributions, the right provider will provide the proper guidance, customer support, expertise, and software to keep these processes streamlined and simplified.
The right payroll service for an S-Corp should be able to complete all of the following processes and more:
- Establishing and managing salary for you, your business partner(s), or shareholders.
- Establishing and implementing a new pay schedule/pay frequency, whether it’s weekly, monthly, or otherwise, and aligning it with your payroll platform.
- Managing shareholder distributions.
4. Additional Best Practices and Legal Requirements
Although determining salary and distributions for yourself and other shareholders is a pivotal best practice, you should also gain an understanding of accountable plans, state tax requirements, deductions, health insurance premiums, and payroll tax statements. These are important legal and tax-related requirements that keep your S Corp compliant with regulations and simplify some of your payroll processes.
- A Plan allows your employees to be reimbursed for business-related expenses proven within a reasonable timeframe. Fundamentally, an Accountable Plan permits an owner-employee (as just one example) to redirect business expense deductions to the employer (the S Corp). This reduces personal tax liability and assists with overall payroll management. Your payroll provider can help you and the other employees in your S Corp properly document business expenses and retain those documents in the event of excess payments or IRS inquiries.
- Your payroll service provider should help your S Corp align with local and state payroll tax requirements. Managing these taxes can help reduce your corporate tax liability.
- If you are an owner-employee of an S Corp and pay for health insurance premiums, these funds can actually be calculated as wages paid (Box 1) by the company in your tax returns. By taking this approach, you can claim insurance premium costs as a personal tax return deduction while bypassing FICA taxes on those payments.
- Making timely payroll tax payments is essential and easy for S Corps to mishandle when the process of completing W-4s, managing withholdings, making monthly payroll tax payments, and maintaining a payroll schedule is handled entirely in-house. A qualified provider should help you with these major facets of payroll service in addition to helping you identify more specialized opportunities for tax benefits and improved yearly compensation.
Efficient and Accurate S Corp Payroll
Transitioning to an S Corp tax designation can be a major benefit to your business. Completing (and routinely managing) the logistical and payroll-related processes is a tall order. That’s why ABS Payroll & HR alleviates the need for in-house payroll management by providing the expertise, customer support, and software to help your S Corp efficiently run payroll, capitalize on a host of tax benefits, and remain legally compliant amid regulatory changes.