Why S Corp Owners Must Be on Payroll
Running an S Corporation (S Corp) can offer significant advantages, including tax benefits and liability protection. However, to fully comply with IRS regulations and maximize these benefits, S Corp owners need to ensure they are on payroll. This article will explain why being on payroll is beneficial for S Corp owners, outline the steps to set up payroll correctly, and answer some frequently asked questions.
Why S Corp Owners Need to Be on Payroll
Compliance with IRS Regulations
The IRS mandates that S Corp owners who perform substantial services for the company must be paid a reasonable salary. This salary should reflect the market rate for the services rendered. Failure to comply with this requirement can result in serious penalties, including fines and back taxes.
Avoiding IRS Scrutiny
Being on payroll helps S Corp owners avoid IRS scrutiny and potential audits. The IRS actively monitors S Corps to ensure that owners are not underreporting their salaries to avoid paying payroll taxes. By paying yourself a reasonable salary, you demonstrate compliance and reduce the likelihood of an audit.
Social Security and Medicare Contributions
When S Corp owners are on payroll, both the company and the owner contribute to Social Security and Medicare taxes. These contributions are necessary for building retirement benefits and ensuring access to healthcare in the future. Not paying yourself a salary can lead to insufficient contributions and negatively impact your Social Security and Medicare benefits.
Tax Planning Opportunities
Having a structured payroll allows for better tax planning. S Corp owners can strategically balance their compensation between salary and distributions. While salaries are subject to payroll taxes, distributions are not, allowing for potential tax savings. However, it’s essential to strike the right balance to comply with IRS guidelines and maximize tax efficiency.
Credibility and Professionalism
Putting yourself on payroll enhances the credibility and professionalism of your business. It shows that your S Corp operates like a legitimate business entity, adhering to standard practices. This can be beneficial when dealing with clients, investors, and financial institutions.
How to Set Up Payroll for S Corp Owners
- Determine a Reasonable Salary: Research industry standards for your role and determine a reasonable salary. Consider factors like experience, duties, and geographic location.
- Register for Payroll Taxes: Ensure your S Corp is registered for federal and state payroll taxes. Obtain an Employer Identification Number (EIN) if you don’t already have one.
- Choose a Payroll System: Select a payroll system or service to handle payroll processing, tax withholdings, and filings. There are many reputable payroll service providers that cater to small businesses.
- Run Payroll Regularly: Process payroll on a regular schedule, withholding the necessary taxes and remitting them to the appropriate authorities. Ensure you comply with all federal and state regulations.
- Maintain Records: Keep detailed records of all payroll transactions, including wages paid, taxes withheld, and remittances. This documentation is crucial for tax reporting and potential audits.
FAQs
What constitutes a “reasonable salary” for an S Corp owner?
A reasonable salary is one that reflects the market rate for the services you provide to your S Corp. Factors such as your experience, duties, time commitment, and industry standards should be considered. It’s advisable to document how you determined the salary to support your decision in case of an audit.
Can S Corp owners pay themselves only through distributions?
No, S Corp owners cannot pay themselves solely through distributions. The IRS requires that a reasonable salary be paid before any distributions are made. Paying only distributions can lead to penalties, fines, and back taxes, as distributions are not subject to payroll taxes.
What are the penalties for not putting an S Corp owner on payroll?
If the IRS determines that an S Corp owner is not receiving a reasonable salary, the penalties can be severe. The IRS may reclassify distributions as wages, leading to back taxes on unpaid payroll taxes, interest on the unpaid amounts, and substantial penalties. This can result in significant financial and operational burdens for the business.
Conclusion
Being on payroll is not just a regulatory requirement for S Corp owners; it’s a strategic move to ensure compliance, optimize tax benefits, and enhance the credibility of your business. By following the outlined steps and understanding the importance of a reasonable salary, S Corp owners can navigate the complexities of payroll and focus on growing their business.
Visit Cirrus Payroll to learn more about how we can help you simplify your payroll process.