S Corp Tax StrategiesHow to set a reasonable S corp salary and start payroll

What a reasonable salary means

Once your company is an S corp, every owner who works in the business needs a salary paid through payroll before taking distributions. The IRS calls it reasonable compensation. In plain terms, it's the going rate for the job you do there.

The IRS lists these factors for deciding what's reasonable:

• your training and experience
• your duties and responsibilities
• the time and effort you put into the business
• the company's history of paying distributions
• what the business pays employees who aren't owners
• how and when bonuses are paid to key people
• what similar businesses pay for similar work
• any pay agreements, and whether a formula is used

Ways to find your number

Start with what you'd pay someone else to do your job. If your week is split between roles, such as running jobs, selling and keeping the books, price each role for the hours you spend on it and add them up. Pay surveys and job listings for similar work in your area help.

Then compare that number to your profit. A salary that uses up nearly all the profit leaves little to save. A salary far below the work can be questioned. We help you land on a number that fits, and we write it up in a short memo for your file that shows the work and the sources.

How the salary affects other tax breaks

The qualified business income deduction is figured on the profit left after your salary, so a higher salary can shrink it. Above an income level that's set each year, the deduction can depend on the wages the business pays, so a salary can help. We compare both before you set the number.

Contributions to a solo 401(k) or a SEP are based on your W-2 wages from the S corp, so the salary also sets how much you can put toward retirement. If the company pays your health insurance as an owner of more than 2%, the premiums go on your W-2 as wages for income tax, without Social Security or Medicare tax when the plan rules are met.

Payroll setup, step by step

1. Pick a payroll provider. We help you choose one that fits a small company and your budget.
2. Open the state accounts. Most states need a withholding account and an unemployment tax account before the first payday.
3. Set the salary and the pay schedule. Monthly or twice a month works for most owners.
4. Connect the bank account the company pays from, and add yourself as an employee with a Form W-4.
5. Run payday on the schedule. The provider withholds the tax and makes the deposits.
6. Record each payroll in the books, in a wage account kept apart from distributions.

We set payroll up with you. You run each payday with the provider you pick, and we check every month that the books match what payroll reported.

What payroll files for you

Most payroll providers file these forms as part of the service. We check that each one matches the books.

• Form 941 each quarter, due April 30, July 31, October 31 and January 31.
• Form 940 each year for federal unemployment tax.
• Form W-2 to you and to the Social Security Administration by January 31.
• State withholding and unemployment reports, on your state's schedule.

If one of those dates is a weekend or a federal holiday, the form is on time the next business day.

Fixing a past year

Sometimes a prior year can be amended. Sometimes a late election can still be accepted through the relief the IRS describes in the Form 2553 instructions. Both leave a paper trail, and both need a record of what you were paid that you can explain. We look at the past with you and pick the path that fits the facts.

If the year is still open, start the salary going forward and look at the earlier months with your payroll reports in hand. That's usually simpler than rebuilding a year from memory in March.

Taking the rest out as distributions

Once your salary runs through payroll, the profit left can come out as distributions. They're generally tax-free up to your stock basis. Money you put back into the company is a contribution, and it raises your basis.

Give each one its own account in the books: wages, distributions and contributions. When one transfer account does all three jobs, your K-1 can come out wrong even while the bank balance matches.

Questions about S corp salary

Is there a safe percent of profit for the salary? No single percent fits everyone, because the salary follows your duties. We set it from your duties, your hours and what similar businesses pay.

Can my salary change from year to year? Yes. If your role or the business changes, the salary can change with it. We update the memo when it does.

Do I need payroll if I'm the only employee? Yes. A salary for an S corp owner runs through payroll, with withholding and payroll tax, even when you're the only person on it.

Get help with your salary and payroll