If you’re the owner of an S corporation, you may wonder whether you’re considered self-employed and how you should pay yourself. The answer depends on your role in the business and how income is distributed. Let’s break it down:
Are You Self-Employed?
As an S corporation owner who provides services to the business, you’re not considered self-employed traditionally. Instead, you’re classified as an employee-owner subject to specific IRS requirements. Here’s how it works:
Employee: If you perform significant work for your S corporation, the IRS requires you to be treated as an employee and pay yourself a reasonable salary via W-2 wages.
Shareholder: As a shareholder of an S corporation, you’ll also receive a share of the business’s profits through K-1 distributions. These distributions are not subject to self-employment taxes.
How to Pay Yourself in an S Corp
You’re both an employee and an owner of your business, so your compensation is split into two parts:
1. Reasonable Salary (W-2):
You must pay yourself a reasonable salary for the work you perform. This salary:
Is reported on a W-2.
Is subject to payroll taxes like Social Security and Medicare.
It must align with what others in similar roles and industries earn.
The IRS scrutinizes S corporations that avoid paying salaries to shareholder-employees to reduce payroll taxes. Failure to pay a reasonable salary can result in penalties and reclassification of distributions as wages.
2. Shareholder Distributions (K-1):
After paying yourself a reasonable salary, you can take additional profits as shareholder distributions. These distributions:
Are reported on Schedule K-1.
Are not subject to Social Security or Medicare taxes.
Represent your share of the business’s net income.
What Is a Reasonable Salary?
The IRS requires you to pay a salary that reflects the value of the work you perform. To determine a reasonable salary, consider:
The industry standard for similar roles.
Your skills, qualifications, and experience.
The hours you work and your responsibilities.
Salaries paid to employees in comparable businesses.
Why Does It Matter?
Failing to pay yourself a reasonable salary can have serious consequences:
IRS Audits: If the IRS finds you’re avoiding payroll taxes by taking distributions instead of a salary, they can reclassify distributions as wages.
Penalties and Interest: You may owe back taxes, interest, and penalties on improperly classified distributions.
Compliance Risks: Staying compliant protects your S corporation’s tax advantages.
Key Takeaways:
As an S corporation owner, you are considered an employee of your business if you perform significant services.
Pay yourself a reasonable salary via W-2 wages, subject to payroll taxes.
After paying a reasonable salary, take additional profits as K-1 distributions, which are not subject to employment taxes.
By balancing your compensation between salary and distributions, you can maximize the tax advantages of your S corporation while staying compliant with IRS rules.
Need assistance determining a reasonable salary or setting up payroll for your business? Feel to schedule an appointment with our Enrolled Agent - Business Tax Preparation | Chime In Consults -for personalized guidance. Remember, S corporation tax returns are due on March 15th each year—don’t miss the deadline!
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