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How to Pay Yourself in an S Corporation | Reasonable Salary S Corp - YouTube
Channel: All Up In Yo' Business with Attorney Aiden Durham
[0]
- Hi everyone.
[1]
I'm attorney Aiden Durham
[2]
with 180 Law Co in Denver, Colorado.
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And you're watching,
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All Up In Yo' Business.
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(soft music)
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In this episode of All Up In Yo' Business
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we're gonna go into detail
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about how to pay yourself
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in an S corporation.
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In my last video,
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we talked about how to pay yourself
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in a single member LLC.
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So now, we're gonna compare that with
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the rules and process
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for paying yourself
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in an S corporation.
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But before we get into it,
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please be sure to like subscribe and share
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and check the description
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for some links to some
additional freebie downloads
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and guides too.
[50]
All right so you may recall
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with a single member LLC,
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there really aren't any
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rules or requirements
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with how you pay yourself.
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As long as your LLC's operating agreement,
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doesn't have any
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specific restrictions
or requirements for it.
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You can take a member distribution
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from your LLC
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pretty much any time, in any amount
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and by any method that you choose,
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but it does get a little
bit more complicated
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if we're dealing with an S corporation.
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A quick refresher
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on S corporations.
[84]
If you wanna know
[85]
more about S corporations just in general
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check back to some of my previous videos,
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but an S corporation is a tax election
[94]
that an entity like an LLC
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or a corporation can make.
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So in the majority of instances,
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oftentimes what we end up with
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is a single member LLC
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that's taxed as an S corporation.
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And so that's the
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type of situation that I'm gonna focus
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on here today.
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But these rules really apply
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if you're a corporation taxed as an S corp
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or a multi-member LLC
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taxed as an S corp as well.
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So, when you make an election
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to be taxed as an S corporation,
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you as the owner or member
[128]
become an employee
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of the LLC as well.
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So now not only are you
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a member slash owner,
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you're also an employee.
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S corporations are considered
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pass through entities
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just like an LLC is.
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Like in a single member LLC
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all of the income
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to the business is taxed
as if it's personal income
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to the LLC members.
[152]
There's no separate business
[155]
or corporate tax.
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It's all just subject to
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personal income tax
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of the member
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at their ordinary income tax rate
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plus self employment taxes.
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Now, the same thing applies to
[168]
LLCs that are taxed as an S corporation.
[171]
Even with the S corp election
[173]
all of the income to the business
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is taxed as if it's personal income
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to the members
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regardless of how much or how little
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they actually take for themselves.
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Except where the difference lies
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is in that self employment tax.
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So, as an S corp,
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now that you are
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technically an employee of your company,
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you need to be treated as such.
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That means running payroll
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and withholding FICA
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and all those payroll taxes
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just as it would happen
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if you were an employee
for any other company.
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The LLC is also going to issue you a W-2,
[210]
just like it would
[211]
if you were an employee
of another company,
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or if you had other employees.
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The idea with the S corp
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is that instead of
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all of your income
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being subject to that self employment tax,
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it's your reasonable salary.
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It's your salary as an employee
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where those withholding
and those payroll taxes
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are being taken out.
[231]
So it's only that salary
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that you pay yourself through payroll
[236]
that gets those extra taxes,
[238]
like the self employment tax.
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But since you're an employee,
[241]
it's payroll taxes
[244]
like social security
[245]
and Medicare withholdings
[247]
that are being withheld
from your paycheck.
[249]
So, let's compare this
[250]
with a single member LLC.
[253]
Let's say we are in a business
[255]
and the business has a
[256]
total taxable income of a $100,000.
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For simplicity's sake,
[261]
we're gonna say the taxpayer
[263]
is in a 24% tax bracket
[266]
and then the self employment taxes
[268]
are 15.3%.
[270]
So, rounding it all
[272]
and making it a whole number.
[274]
Essentially, the taxpayer
[275]
is paying 39%
[278]
on that total 100,000 income
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from the business.
[282]
That's the ordinary income tax
[284]
plus the self employment taxes
[286]
applied all to that $100,000.
[289]
Take that same situation,
[291]
but in an S corporation.
[293]
Let's say it's still
[294]
a $100,000 taxable income.
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And the member,
[298]
the owner takes a salary
[300]
of $50,000.
[301]
So that salary,
[302]
that 50,000 is taxed pretty much the same
[306]
with that ordinary income tax
[307]
and then that 15.3% payroll taxes.
[312]
So, that salary essentially
gets that 39% tax applied to it,
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but then everything else
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that additional 50,000
[320]
above the member's salary
[322]
that's taxed just at the owner's
[325]
ordinary income tax rate,
[326]
without that self-employment
[328]
or payroll tax being applied to it.
[331]
So in the single member LLC we've got
[334]
39% taxes applied to a $100,000,
[338]
which works out to about $39,000
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total in taxes
[343]
versus in the S corp
[344]
where we're applying that 39%
[346]
to just the $50,000
[349]
and then 24%
[351]
to the additional $50,000,
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which if you do a little math
[355]
it works out to be about
[356]
31, 500, something like that,
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$31,000.
[361]
So, with the S corp
election in that situation,
[364]
the taxpayer ends up saving
[366]
about $8,000 overall in taxes.
[369]
So the first step in how
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to pay yourself in an S corp
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is to make yourself an employee
[376]
of the LLC.
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In a lot of jurisdictions,
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this is gonna require
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getting a payroll tax withholding license,
[384]
or some other kind of
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tax or employer license.
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It's gonna completely depend on
[390]
your state and your city
[391]
and your jurisdictions
requirements, what they need,
[394]
but in most situations
you're gonna need to make
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some filings with your city and your state
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in order to
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withhold and properly report
[403]
all those payroll taxes.
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You may also need to get
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workers compensation coverage.
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And again, this is dependent on
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where you live and if they
have some kind of exemption.
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In Colorado, if there are
no actual other employees
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and it's only member or owner employees,
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then you can be exempt
[422]
from a workers compensation
coverage requirement.
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So again, that's gonna
depend on where you are,
[428]
and you're also gonna need
[429]
to get yourself set up on payroll.
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So how do you do that?
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There are a lot of different ways.
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There are a lot of
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online payroll companies that are
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relatively inexpensive
and pretty easy to use.
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With many of 'em
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you just input your
[445]
pay rate or your salary rate
[447]
and they calculate all the taxes.
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They figure out what needs to be withheld
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and then they often take
care of all the filings
[454]
and all the reporting too,
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which is really important
in your payroll service,
[459]
whatever it is,
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is making sure they handle
[462]
all aspects of it.
[464]
And then typically they'll take
care of all those reportings
[466]
and then either
[467]
send you a check
[469]
or do a direct deposit
into your bank account.
[471]
I used ADP before
[474]
when I was first starting
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and I was really happy with them.
[478]
Intuit, which is the
company behind QuickBooks.
[481]
They have a payroll
[483]
service online as well.
[485]
And then I've also heard
[487]
good things about Gusto,
[488]
which is a
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kinda HR program,
[491]
but I've heard a lot of
good things with regard to
[493]
their payroll service too.
[495]
I don't have any experience
aside from with ADP,
[498]
but that's just what I've heard in,
[500]
passings at the water cooler
[502]
as far as online payroll services go.
[504]
So if you pay yourself
a salary via payroll,
[508]
then everything else on top of that,
[511]
that the business makes
[513]
or that you take for yourself
[514]
is considered a member distribution.
[516]
So if your business makes a $100,000,
[519]
you can take 50,000
[521]
as a salary.
[523]
And then the remaining 50,000
is considered a distribution.
[526]
Or if it's an S corp a,
[528]
if it's a corporation
[529]
taxed as an S corp
[530]
then it might be referred
to as a dividend instead
[533]
because it's a shareholder
rather than a member.
[536]
But the point is that
[538]
the payroll part has these taxes
[540]
and then the rest is a
distribution or a dividend.
[543]
When you're considering
[545]
paying yourself and how
much to pay yourself
[547]
and how to pay yourself.
[548]
It's really important that your
[550]
bank is in line
[552]
with your goals and your plans.
[554]
For example, you may not want to bank
[556]
with a bank that charges extra
[558]
for a direct deposit
[559]
if you plan on direct depositing.
[561]
Or if they charge extra to
[564]
do ACH transfers,
[565]
or if you can't easily transfer,
[567]
then you may not wanna use that bank.
[570]
But that's an important thing to consider
[572]
when you're starting an S corp
[574]
or starting any kind of a business really.
[576]
It's also really helpful if your bank
[579]
integrates or somehow connects with your
[582]
bookkeeping or your payroll software too
[585]
so it can all talk to each other.
[586]
I was recently introduced
[588]
to a bank called Novo.
[590]
It's a completely online bank
[592]
and you can apply
[594]
and open a business checking account
[596]
online in minutes.
[598]
It's super easy,
[599]
which I love.
[600]
You don't even have to leave your house
[602]
or talk to a person on the phone
[603]
and you can open a checking account.
[604]
You only need 50 bucks
[606]
to initially fund the
account to get it open
[609]
and Novo lets you
[610]
link to other banks
[612]
so you can quickly and
easily transfer that money
[615]
into your new checking account.
[616]
The super cool part though,
[618]
is that Novo has an integration with Zero
[621]
which is a really popular
bookkeeping software.
[624]
So if you
[625]
use Novo and you use Zero
[628]
which I believe Zero
[629]
has their own payroll processing
[631]
or they integrate with some
other payroll processing,
[634]
but so you can link up Novo
[636]
to Zero to your payment processor
[639]
and now everything's talking
[640]
and communicating to each other.
[642]
You don't have to double enter anything
[644]
and it just streamlines your
accounting process immensely.
[648]
Novo also lets you integrate
with other apps like Zapier.
[651]
So, you can easily connect your bank to
[655]
any other programs or apps
that you might be using too.
[657]
And then when you need
to take a distribution,
[660]
you can just quickly transfer
[662]
money from your Novo business account
[664]
into your personal account
[666]
whatever bank that's with.
[667]
And, you don't have to
think about it again.
[669]
It's just like three clicks
[671]
and you've transferred money
[672]
and you paid yourself through
a member distribution.
[674]
So, Novo is a great option
[677]
and the best part is, is completely free.
[679]
They don't have any
[680]
fees to open an account,
[682]
no minimum balance requirements,
[685]
no ACH or wire transfer fees.
[688]
Everything is free,
[689]
which is of course the best part about it
[691]
is not having to pay for your
business checking account.
[694]
And, if you use the affiliate code
[697]
in the description
[698]
and open a new account,
[699]
you can get a $25 credit
[701]
directly into your new account with Novo
[704]
using the affiliate
link in the description.
[707]
My recommendation however,
[709]
aside from using the
online payroll services
[712]
is to work with a tax professional
[715]
who can help you with all aspects
[718]
of your accounting and bookkeeping.
[720]
Finding a CPA or another pro who can
[724]
take care of your payroll for you
[726]
and all your tax filings
[728]
and hopefully your bookkeeping
and everything else
[731]
is really an ideal situation.
[733]
So you have everything in one place
[735]
and one person
[736]
who can advise you
[737]
with regard to all of (mumbles).
[739]
Why is it so important
[740]
to have a CPA help you?
[742]
Well, that takes me to
the second part of the how
[745]
you pay yourself in an S corp
[747]
which is how much
[749]
do you pay yourself in an S corp.
[751]
Now that you know
[753]
how an S corp is taxed,
[755]
your brain might be turning
[757]
with some ideas for extreme tax savings.
[760]
Something like, oh, I'll just take
[762]
a really, really tiny salary
[765]
and then take the rest
[766]
as a distribution.
[768]
So only this little salary
gets those extra taxes,
[771]
but the rest is just a distribution
[773]
without the self employment
or payroll taxes.
[776]
Sorry, unfortunately you can't do that.
[778]
The IRS requires in an S corp
[781]
that the owners take a
[783]
reasonable salary for themselves
[785]
and reasonable is the,
[788]
the important term here.
[790]
Of course, the IRS doesn't really tell us
[792]
what reasonable means.
[795]
Here's a fun little anecdote
[797]
for you about how
[799]
the law works.
[800]
So, lawmakers will
[802]
draft these laws
[803]
and they use these kind of open ended
[806]
or ambiguous terms like reasonable
[809]
and nobody including
the lawmakers themselves
[812]
really knows what
[814]
reasonable means in this law.
[816]
It's only when there's a legal issue
[819]
or a case that comes up
[822]
when that law is applied
[824]
to those situations.
[825]
It's only then when we get some
[827]
indication of what
[829]
that word means.
[831]
But even then all we really know is that
[834]
in this specific case
[836]
with these specific facts
[838]
this salary was or was not reasonable.
[841]
But so that's basically what we have
[843]
to go off of
[844]
when determining what
a reasonable salary is.
[847]
So, pretty much all of that to say
[849]
that the only way
[851]
that we know what
[852]
constitutes a reasonable salary
[854]
is based off of previous
situations where the IRS has said,
[858]
yes, that's reasonable
[859]
or no, that's not reasonable.
[860]
And there are a lot of different
[862]
schools of thought
[863]
that go into how you determine
[865]
what a reasonable salary is.
[867]
According to my CPA
[869]
and many of my other accounting colleagues
[873]
the kind of general rule of thumb
[876]
or a good rule to abide by
[878]
is to have your salary be
[880]
about 50% of
[883]
the business's net income.
[885]
So again, this comes from
[886]
previous IRS rulings
[889]
and cases where the IRS has determined
[892]
what a reasonable salary is.
[894]
So in one case,
[896]
the IRS said
[897]
a 49% salary
[900]
versus net income was reasonable.
[902]
Whereas in some other cases they said
[904]
59% was reasonable.
[907]
So, going off of some of those
[909]
legal precedents and case history,
[912]
we get an idea that
[914]
if you're paying yourself around 50%,
[917]
the IRS typically is
going to consider that
[919]
to be reasonable.
[921]
But again, it's,
[922]
it's always very fact dependent
[925]
and completely dependent on
[927]
specific facts and circumstances.
[929]
So, we can't say
[931]
50% and you're good.
[933]
You're not gonna have
anything to worry about.
[935]
We can really just say,
[936]
we know in the past
[937]
50% has been acceptable.
[939]
So, we're gonna kinda ride off of that.
[941]
So, that's really why I recommend
[943]
working with a tax professional
[946]
when you are making an S corp election,
[948]
or if you're running an S corporation
[950]
to make sure you're
[951]
paying yourself enough
[953]
and not too much
[955]
through that salary
[956]
because if you overpay
through your salary,
[959]
then you're overpaying taxes.
[960]
You can pay a 100% of your ta,
[963]
of your salary through payroll,
[965]
but now you might be overpaying.
[967]
So working with
[968]
a professional who can
help you figure that out
[970]
is the best thing to do.
[972]
And I'll tell you guys,
that's exactly what I do.
[974]
I have a CPA
[976]
and an accounting team that I work with
[978]
that handles everything
[980]
for my business on the tax end.
[982]
So they do my payroll,
[984]
all of my tax filings, everything,
[986]
all of my bookkeeping and all of that.
[988]
So what they do is every month
[990]
they do my books,
[991]
they reconcile everything
[993]
and they determine what my
[994]
net income was for that month.
[997]
And based off of that,
[998]
they figure out how much
I need to pay myself.
[1001]
So that we keep
[1002]
around that 50% range
[1005]
for my salary.
[1006]
So I don't do any math.
[1008]
I don't have to think about it.
[1009]
I get an email once a month saying,
[1012]
here is your profit and loss
[1014]
and here is how much we are.
[1015]
Here is what we wanna pay you
[1017]
for payroll this month.
[1018]
And so with them,
[1019]
keeping their eye out
[1021]
and doing the calculations,
[1022]
I can be assured that
[1024]
I'm not overpaying,
[1026]
but that I'm
[1027]
safely paying myself enough to
[1029]
hopefully be within
[1031]
the acceptable reasonable range
[1033]
for the IRS.
[1034]
So, once it comes to tax time,
[1037]
the process is also a little bit different
[1040]
when we're talking about S corps
[1041]
versus just a single member LLC.
[1043]
Once you're taxed as an S corporation
[1046]
the S corp has to file
[1048]
its own corporate return
[1050]
which is in the form of 1120 S
[1053]
that's the IRS form that you use.
[1055]
One, one, two, zero S
[1057]
and then the LLC is going to issue a K one
[1061]
to the members.
[1062]
And the K one describes the,
[1065]
share the members share
[1066]
of the profit and losses.
[1068]
So, in a single member LLC
[1070]
that's taxed as an S corporation.
[1072]
The K one just allocates
all of the profit or loss
[1075]
to the one member.
[1077]
And then the LLC is also
going to need to issue a W-2
[1080]
to the member slash employee.
[1083]
And then the member will use
[1084]
that W-2 and the K one
[1086]
to prepare their personal
income tax return
[1089]
on form 1040
[1091]
and file that
[1092]
and then that's where all
the taxes are paid from.
[1094]
So the primary benefit
[1096]
of being taxed as an S corporation
[1098]
is that it really does have
[1099]
the possibility of
[1101]
drastically limiting your
overall tax liability.
[1105]
But along with that
[1106]
is the additional accounting
[1108]
and administrative work
[1109]
and the extra
[1111]
hassle of making sure
you're paying yourself
[1113]
the right amount through payroll.
[1115]
So compared to an LLC,
[1117]
it saves you in taxes,
[1119]
but there's more work that goes into it.
[1121]
So because of that
[1122]
and because of all the intricacies
[1124]
and dealing with the IRS,
[1126]
it's always a good idea to
make sure you're working with
[1129]
a tax professional and a business attorney
[1131]
to make sure the S corporation
[1133]
is the appropriate move for you.
[1135]
And of course to make sure
[1136]
you are paying yourself correctly
[1138]
and handling all the filings properly too.
[1140]
That's all for this episode.
[1143]
Drop a comment below and
let me know what you think.
[1145]
And again, don't forget
to check the description
[1148]
for my free downloadable guides
[1150]
and check sheets too.
[1152]
Thank you all so much for watching.
[1154]
I'm Aiden Durham,
[1155]
and I'll see you next time.
[1158]
(soft music)
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