Maintaining accurate and detailed records is essential to running an S Corp payroll. Unfortunately, even single-owner S Corps can get a bit lax on record-keeping, and this can come back to haunt them during tax audits. Records must include the wages paid to each employee and income tax, unemployment, and social security taxes.
Tax implications
Many considerations should be made when calculating payroll for an S Corp. The first thing is to consider the compensation levels of employees. The S corporation should be able to justify a higher salary if the employees are more experienced or provide professional services. Therefore, the wages should be documented. Also, while the IRS will not object to S Corp owners paying anything, paying employees reasonable compensation is a good idea.
Another essential factor to consider is whether the compensation levels of shareholders are reasonable. Some shareholders may prefer to receive dividends rather than compensation payments. Dividend distributions are not subject to payroll taxes, but the IRS requires S corporations to provide shareholders with “reasonable” compensation. Tax court cases in recent years have provided a framework for determining reasonable compensation.
Documentation
When you want to start an S Corp payroll, you will need to get a nine-digit Tax ID number from the IRS. This is also known as an Employer Identification Number or Federal Employer Identification Number. This number will allow you to set up and maintain your payroll. You can get this number by working with a payroll service provider or doing it yourself.
You should also keep detailed records of wages not paid and hours worked by shareholders. If you’re unsure what salaries are being paid in your area, you can look up wage information from the U.S. Department of Labor’s Bureau of Labor Statistics. They have detailed wage data for over 800 occupations and provide wage information by state, city, and county.
Employee compensation
The S corporation must pay reasonable compensation to its shareholder-employees who provide services to the S corporation. This compensation must be paid before non-wage distributions may be made. For example, if the company has an allocation for 2017 and earnings for 2016 and 2017, the compensation paid to Scott must be at least $79,950.
An S Corp owner should base their compensation on industry standards rather than the average salary of other S Corps. The IRS has released annual reports that show average salaries for S Corporations, but these reports don’t consider individual circumstances. So instead, look at the total compensation paid to your employees, including salary, bonuses, and health benefits on W-2s.
The IRS defines a reasonable salary as the amount similar businesses pay for the same type of service. However, this definition is somewhat vague, and you must research to determine a reasonable salary for an S Corp employee accurately. For example, you can consult the Bureau of Labor Statistics, which has salary information for hundreds of jobs.
Filing state income tax
You may have to file state income taxes on your employees’ paychecks if you’re an S corporation. However, some states do not require this. For example, Delaware and New Jersey don’t require S corporations to file state income taxes on the payroll of nonresident shareholders. North Carolina and Oklahoma do, however. In addition, some states require S corporations to file composite payments treated as estimated taxes.
S Corporations pay two types of income to active shareholders. First, wage income is subject to the payroll tax, which is 2.9 percent of the first $117,000 net earnings. On the other hand, a profit distribution is not subject to payroll tax. This means that an owner of $200,000 with half of the wages paid as payroll must pay $15,300 of payroll taxes, while the other half goes to expenses.
Forms to file
There are many forms that S Corporations need to file to pay employees. They may also be required to file with Social Security Administration. If you want to simplify filing these forms, consider using a payroll service like ConnectPay.
An S Corp payroll and a standard payroll are different. Shareholders are allowed to receive their pay more frequently. Some S corporations pay quarterly, while others pay monthly. Big end-of-year bonuses can help you meet a reasonable salary.
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