S corps are required to pay their owners a “reasonable compensation” through payroll as employees. Your business will pay FICA payroll taxes (7.65% of your salary) and you personally will pay FICA taxes (7.65% of your salary). S corp owners can draw money from the business by using shareholder distributions instead of dividends.
Qualifying for S Corporation Status
To qualify for S corporation status, the corporation must:
- Be a domestic corporation
- Have only allowable shareholders
- Have no more than 100 shareholders
- Not be partnerships, corporations or non-resident alien shareholders.
The owner’s salary in an S corp is a business expense. Any net profit not used to pay salaries or taken as a draw is taxed at the corporate rate, lower than the personal rate.
The IRS can recharacterize distributions as salary and require back taxes and penalties if salaries seem unreasonable.
Determining a Reasonable Salary
Factors to determine reasonable salaries include:
- Training and experience
- Duties and responsibilities
Before running payroll, S Corp owners need Employer Identification Numbers (EINs) and set up employer accounts. A reasonable salary is what similar roles get paid by employers. Payroll taxes and net payroll must be calculated and taxes filed.
Dividends and distributions for investment are taxed differently than salaries, with dividends not being taxed.
Owners can receive distributions from profits regularly.