New entrepreneurs frequently question how to pay themselves from an S-Corp. So, how to pay yourself from an S-Corp the right way? As a Shareholder-employee of an S-Corp, you must be paid a reasonable salary. However, even if your business is losing money, you can still distribute the excess funds to yourself as shareholder distributions, free of payroll taxes. In this article, we’ll review the basics of this complex process.
Shareholder-Employees Must Receive a Reasonable Salary
There are many differences between shareholder-employees and their tax advisers when calculating a reasonable salary for an S-Corp’s SEs. Shareholder employees tend to limit their compensation and prefer distributions to keep payroll taxes low. Tax advisers, however, must follow IRS guidelines. In other words, they cannot allow us to forgo a reasonable salary. Unfortunately, there is little guidance for tax advisers, who may not know what a good salary is for their company.
The IRS has issued a ruling on the matter, stating that S-Corps shareholders are considered employees under the tax law. Under IRS rules, a reasonable salary must be more than the value of services provided by an employee in the same industry. Therefore, if a shareholder offers more than money to a company, they are employees and should be paid a comparable wage.
The 60/40 rule Determines Employee Salaries
If you consider forming an S corporation, you may have heard about the 60/40 rule, which divides revenue between salary and profit distribution. The 60/40 rule may help you determine the proper salary structure, but it may not pass the IRS muster. Additionally, you may end up paying more taxes than necessary and leaving unused funds in the company. In other words, you should carefully consider the 60/40 rule before establishing the salary of an S corporation’s SE.
However, it is crucial to pay yourself a reasonable salary. If you spend less than a similar position, you risk getting into trouble with the IRS. The 60/40 rule ensures that you pay yourself a salary commensurate with another employee’s wages. Likewise, the 60/40 rule helps protect your business from penalties imposed by the IRS if you fail to pay your compensation.
Form 941 is Used to File Federal Payroll Taxes
There are several things to remember when filing federal payroll taxes from an S-Corp. The first thing to remember is that the first line on Form 941 only applies to the first box. It is not required to fill out lines two and three. You should make your payments online, using a credit card or PayPal. Enter your EIN, payment amount, and business name and address.
Most businesses with employees must file IRS Form 941 every quarter. Other states have analogs for this form. You do not need to file Form 941 if you employ household employees or only a few seasonal workers. The deadline for filing is the last day of the month after the quarter ends. You can extend this deadline by ten days if you make payroll tax deposits on time throughout the quarter.
Fees are Paid Through the Federal Unemployment Tax Act
Some states require specific types of S corporations to file a Federal Unemployment Tax Return. To qualify, the corporation must pay at least $1,500 in wages each quarter and have at least ten employees working some part of each day during 20 different weeks. Other states require farm businesses to hire workers for a minimum of twenty hours per week. While this is not necessary for small businesses, the cost of filing a Federal Unemployment Tax Return is a 6 percent tax on wages. Employers can opt to pay less by contributing to state unemployment funds.
The fees associated with an S corporation must be reported to the IRS. If the corporation has employees, the officers and members of the LLC are treated as employees. S-Corps, LLCs, and partnerships are subject to unemployment tax laws. Generally, they must file Form 1120S for federal tax purposes and to pay FICA and unemployment taxes for their employees. In addition to filing federal tax returns, S-Corps and LLCs must file quarterly reports reporting the payroll taxes withheld from their employees’ pay. In some states, shareholder-employees may be required to file a Form 1040-ES (estimated tax) to report additional income.