How to start paying yourself a reasonable salary, and is it time to give yourself a raise?
Today, we’re going to talk about something crucial for business owners: How to pay yourself the right way so you don’t end up sending the wrong message to the IRS—and potentially paying unnecessary taxes.
Step 1: Understand How You Earn Money in Your Business
As a business owner, you actually earn money in two ways: through distributions and salary.
1. Distributions
Distributions are the profits (or losses) that pass through your business to you as the owner or shareholder. Importantly, distributions are not considered wages, and they aren’t treated as self-employment income.
You don’t have to pay payroll taxes on distributions from an S Corp.
2. Salary
Salary is the money you pay yourself as an employee of the S Corp—your employee wages or "reasonable compensation."
You do have to pay payroll taxes on your salary, just like any other employee.
The takeaway? Paying yourself through distributions instead of salary can save you on payroll taxes—but, there’s a catch.
Step 2: What is a "Reasonable Salary" for an S Corp?
Now that we know the difference, let’s talk about what qualifies as a reasonable salary for an S Corp.
The IRS requires that S Corps must pay their owners a reasonable salary—especially if the owner takes distributions from the company’s profits.
But what does “reasonable salary” actually mean?
The IRS defines a reasonable salary as one that is at least what similar businesses pay for comparable services. It's mostly up to you to decide how much of your income to take as salary and how much to take as distributions, but it has to follow the IRS guidelines. Here's what you should keep in mind:
Consider your role: What are your responsibilities? What’s your experience and training? How much time do you spend working in your business?
Research similar businesses: Look at compensation data from businesses similar to yours in your industry. Websites like Glassdoor, Payscale, and the Bureau of Labor Statistics can help you get a sense of industry standards.
Look at compensation agreements: If you’ve agreed to specific compensation plans with partners or other shareholders, stick to those agreements.
Remember: The IRS can’t require a specific minimum salary—so if your business isn’t generating enough yet to pay yourself a salary comparable to others in your field, don’t worry.
Just make sure that any distributions you take are in proportion to your reasonable salary.
Step 3: How to Pay Yourself
Now that we’ve established how much you should pay yourself, let's talk about how to actually pay yourself!
Once you’ve established your business as a legal entity, paying yourself gets a little more complicated than just collecting income from clients or customers. It’s important to operate like a legitimate business—even if you're the only one on payroll.
Check Your State Requirements
First, check the state-specific requirements for S Corps, as each state has its own rules regarding payroll taxes and contributions.
How Often Should You Pay Yourself?
As an S Corp, it’s up to you to determine how often to pay yourself. While some owners opt for an annual salary, it’s smarter to pay yourself at least quarterly. Why? Because your business might need to make quarterly payroll tax payments, and you’ll also need to file quarterly employment tax returns.
What If You Need More Money?
If you need to boost your income, you can take a shareholder distribution at any time. This is a simpler and more tax-efficient way to pay yourself because you don’t have to withhold taxes on the distribution.
Insider Tip: Bonuses!
You don’t have to pay yourself the same salary every payday. You can pay yourself a smaller salary throughout the year and then give yourself a larger year-end bonus to make up the difference. This can be a smart way to manage your cash flow and tax liabilities.
Summary
Running a business taxed as an S Corp is a smart way to save on taxes, but it's important to balance your salary and distributions to comply with IRS rules. Your goal should be to meet tax requirements while paying yourself a fair wage that reflects your worth.
Remember: You wouldn’t pay an employee an unfair wage, so don’t accept that for yourself either!
If this conversation leaves you feeling a bit overwhelmed, it might be time to get professional help. Don’t wait until tax time to figure out what you could have done differently to save yourself some money.
Need Help Paying Yourself or Navigating S Corp Taxes?
If you need assistance with your business finances or figuring out how to pay yourself the right way, feel free to message me or drop a comment below with "next steps." I’d be happy to reach out and see how I can help you!
At the end of the day, managing your taxes and staying compliant with S Corp requirements can be time-consuming, but you don’t have to do it alone. Many business owners choose to work with a bookkeeper, accountant, or payroll service to handle these tasks so they can focus on growing their business.
Thanks for reading and remember, you deserve to feel confident in how you pay yourself and run your business. If you ever feel unsure, you don’t have to figure it out alone. I’m here to help.
Knowledge is power,
Tereasa
