- Hi everyone.
I'm attorney Aiden Durham
with 180 Law Co in Denver, Colorado.
And you're watching,
All Up In Yo' Business.
(soft music)
In this episode of All Up In Yo' Business
we're gonna go into detail
about how to pay yourself
in an S corporation.
In my last video,
we talked about how to pay yourself
in a single member LLC.
So now, we're gonna compare that with
the rules and process
for paying yourself
in an S corporation.
But before we get into it,
please be sure to like subscribe and share
and check the description
for some links to some additional freebie downloads
and guides too.
All right so you may recall
with a single member LLC,
there really aren't any
rules or requirements
with how you pay yourself.
As long as your LLC's operating agreement,
doesn't have any
specific restrictions or requirements for it.
You can take a member distribution
from your LLC
pretty much any time, in any amount
and by any method that you choose,
but it does get a little bit more complicated
if we're dealing with an S corporation.
A quick refresher
on S corporations.
If you wanna know
more about S corporations just in general
check back to some of my previous videos,
but an S corporation is a tax election
that an entity like an LLC
or a corporation can make.
So in the majority of instances,
oftentimes what we end up with
is a single member LLC
that's taxed as an S corporation.
And so that's the
type of situation that I'm gonna focus
on here today.
But these rules really apply
if you're a corporation taxed as an S corp
or a multi-member LLC
taxed as an S corp as well.
So, when you make an election
to be taxed as an S corporation,
you as the owner or member
become an employee
of the LLC as well.
So now not only are you
a member slash owner,
you're also an employee.
S corporations are considered
pass through entities
just like an LLC is.
Like in a single member LLC
all of the income
to the business is taxed as if it's personal income
to the LLC members.
There's no separate business
or corporate tax.
It's all just subject to
personal income tax
of the member
at their ordinary income tax rate
plus self employment taxes.
Now, the same thing applies to
LLCs that are taxed as an S corporation.
Even with the S corp election
all of the income to the business
is taxed as if it's personal income
to the members
regardless of how much or how little
they actually take for themselves.
Except where the difference lies
is in that self employment tax.
So, as an S corp,
now that you are
technically an employee of your company,
you need to be treated as such.
That means running payroll
and withholding FICA
and all those payroll taxes
just as it would happen
if you were an employee for any other company.
The LLC is also going to issue you a W-2,
just like it would
if you were an employee of another company,
or if you had other employees.
The idea with the S corp
is that instead of
all of your income
being subject to that self employment tax,
it's your reasonable salary.
It's your salary as an employee
where those withholding and those payroll taxes
are being taken out.
So it's only that salary
that you pay yourself through payroll
that gets those extra taxes,
like the self employment tax.
But since you're an employee,
it's payroll taxes
like social security
and Medicare withholdings
that are being withheld from your paycheck.
So, let's compare this
with a single member LLC.
Let's say we are in a business
and the business has a
total taxable income of a $100,000.
For simplicity's sake,
we're gonna say the taxpayer
is in a 24% tax bracket
and then the self employment taxes
are 15.3%.
So, rounding it all
and making it a whole number.
Essentially, the taxpayer
is paying 39%
on that total 100,000 income
from the business.
That's the ordinary income tax
plus the self employment taxes
applied all to that $100,000.
Take that same situation,
but in an S corporation.
Let's say it's still
a $100,000 taxable income.
And the member,
the owner takes a salary
of $50,000.
So that salary,
that 50,000 is taxed pretty much the same
with that ordinary income tax
and then that 15.3% payroll taxes.
So, that salary essentially gets that 39% tax applied to it,
but then everything else
that additional 50,000
above the member's salary
that's taxed just at the owner's
ordinary income tax rate,
without that self-employment
or payroll tax being applied to it.
So in the single member LLC we've got
39% taxes applied to a $100,000,
which works out to about $39,000
total in taxes
versus in the S corp
where we're applying that 39%
to just the $50,000
and then 24%
to the additional $50,000,
which if you do a little math
it works out to be about
31, 500, something like that,
$31,000.
So, with the S corp election in that situation,
the taxpayer ends up saving
about $8,000 overall in taxes.
So the first step in how
to pay yourself in an S corp
is to make yourself an employee
of the LLC.
In a lot of jurisdictions,
this is gonna require
getting a payroll tax withholding license,
or some other kind of
tax or employer license.
It's gonna completely depend on
your state and your city
and your jurisdictions requirements, what they need,
but in most situations you're gonna need to make
some filings with your city and your state
in order to
withhold and properly report
all those payroll taxes.
You may also need to get
workers compensation coverage.
And again, this is dependent on
where you live and if they have some kind of exemption.
In Colorado, if there are no actual other employees
and it's only member or owner employees,
then you can be exempt
from a workers compensation coverage requirement.
So again, that's gonna depend on where you are,
and you're also gonna need
to get yourself set up on payroll.
So how do you do that?
There are a lot of different ways.
There are a lot of
online payroll companies that are
relatively inexpensive and pretty easy to use.
With many of 'em
you just input your
pay rate or your salary rate
and they calculate all the taxes.
They figure out what needs to be withheld
and then they often take care of all the filings
and all the reporting too,
which is really important in your payroll service,
whatever it is,
is making sure they handle
all aspects of it.
And then typically they'll take care of all those reportings
and then either
send you a check
or do a direct deposit into your bank account.
I used ADP before
when I was first starting
and I was really happy with them.
Intuit, which is the company behind QuickBooks.
They have a payroll
service online as well.
And then I've also heard
good things about Gusto,
which is a
kinda HR program,
but I've heard a lot of good things with regard to
their payroll service too.
I don't have any experience aside from with ADP,
but that's just what I've heard in,
passings at the water cooler
as far as online payroll services go.
So if you pay yourself a salary via payroll,
then everything else on top of that,
that the business makes
or that you take for yourself
is considered a member distribution.
So if your business makes a $100,000,
you can take 50,000
as a salary.
And then the remaining 50,000 is considered a distribution.
Or if it's an S corp a,
if it's a corporation
taxed as an S corp
then it might be referred to as a dividend instead
because it's a shareholder rather than a member.
But the point is that
the payroll part has these taxes
and then the rest is a distribution or a dividend.
When you're considering
paying yourself and how much to pay yourself
and how to pay yourself.
It's really important that your
bank is in line
with your goals and your plans.
For example, you may not want to bank
with a bank that charges extra
for a direct deposit
if you plan on direct depositing.
Or if they charge extra to
do ACH transfers,
or if you can't easily transfer,
then you may not wanna use that bank.
But that's an important thing to consider
when you're starting an S corp
or starting any kind of a business really.
It's also really helpful if your bank
integrates or somehow connects with your
bookkeeping or your payroll software too
so it can all talk to each other.
I was recently introduced
to a bank called Novo.
It's a completely online bank
and you can apply
and open a business checking account
online in minutes.
It's super easy,
which I love.
You don't even have to leave your house
or talk to a person on the phone
and you can open a checking account.
You only need 50 bucks
to initially fund the account to get it open
and Novo lets you
link to other banks
so you can quickly and easily transfer that money
into your new checking account.
The super cool part though,
is that Novo has an integration with Zero
which is a really popular bookkeeping software.
So if you
use Novo and you use Zero
which I believe Zero
has their own payroll processing
or they integrate with some other payroll processing,
but so you can link up Novo
to Zero to your payment processor
and now everything's talking
and communicating to each other.
You don't have to double enter anything
and it just streamlines your accounting process immensely.
Novo also lets you integrate with other apps like Zapier.
So, you can easily connect your bank to
any other programs or apps that you might be using too.
And then when you need to take a distribution,
you can just quickly transfer
money from your Novo business account
into your personal account
whatever bank that's with.
And, you don't have to think about it again.
It's just like three clicks
and you've transferred money
and you paid yourself through a member distribution.
So, Novo is a great option
and the best part is, is completely free.
They don't have any
fees to open an account,
no minimum balance requirements,
no ACH or wire transfer fees.
Everything is free,
which is of course the best part about it
is not having to pay for your business checking account.
And, if you use the affiliate code
in the description
and open a new account,
you can get a $25 credit
directly into your new account with Novo
using the affiliate link in the description.
My recommendation however,
aside from using the online payroll services
is to work with a tax professional
who can help you with all aspects
of your accounting and bookkeeping.
Finding a CPA or another pro who can
take care of your payroll for you
and all your tax filings
and hopefully your bookkeeping and everything else
is really an ideal situation.
So you have everything in one place
and one person
who can advise you
with regard to all of (mumbles).
Why is it so important
to have a CPA help you?
Well, that takes me to the second part of the how
you pay yourself in an S corp
which is how much
do you pay yourself in an S corp.
Now that you know
how an S corp is taxed,
your brain might be turning
with some ideas for extreme tax savings.
Something like, oh, I'll just take
a really, really tiny salary
and then take the rest
as a distribution.
So only this little salary gets those extra taxes,
but the rest is just a distribution
without the self employment or payroll taxes.
Sorry, unfortunately you can't do that.
The IRS requires in an S corp
that the owners take a
reasonable salary for themselves
and reasonable is the,
the important term here.
Of course, the IRS doesn't really tell us
what reasonable means.
Here's a fun little anecdote
for you about how
the law works.
So, lawmakers will
draft these laws
and they use these kind of open ended
or ambiguous terms like reasonable
and nobody including the lawmakers themselves
really knows what
reasonable means in this law.
It's only when there's a legal issue
or a case that comes up
when that law is applied
to those situations.
It's only then when we get some
indication of what
that word means.
But even then all we really know is that
in this specific case
with these specific facts
this salary was or was not reasonable.
But so that's basically what we have
to go off of
when determining what a reasonable salary is.
So, pretty much all of that to say
that the only way
that we know what
constitutes a reasonable salary
is based off of previous situations where the IRS has said,
yes, that's reasonable
or no, that's not reasonable.
And there are a lot of different
schools of thought
that go into how you determine
what a reasonable salary is.
According to my CPA
and many of my other accounting colleagues
the kind of general rule of thumb
or a good rule to abide by
is to have your salary be
about 50% of
the business's net income.
So again, this comes from
previous IRS rulings
and cases where the IRS has determined
what a reasonable salary is.
So in one case,
the IRS said
a 49% salary
versus net income was reasonable.
Whereas in some other cases they said
59% was reasonable.
So, going off of some of those
legal precedents and case history,
we get an idea that
if you're paying yourself around 50%,
the IRS typically is going to consider that
to be reasonable.
But again, it's,
it's always very fact dependent
and completely dependent on
specific facts and circumstances.
So, we can't say
50% and you're good.
You're not gonna have anything to worry about.
We can really just say,
we know in the past
50% has been acceptable.
So, we're gonna kinda ride off of that.
So, that's really why I recommend
working with a tax professional
when you are making an S corp election,
or if you're running an S corporation
to make sure you're
paying yourself enough
and not too much
through that salary
because if you overpay through your salary,
then you're overpaying taxes.
You can pay a 100% of your ta,
of your salary through payroll,
but now you might be overpaying.
So working with
a professional who can help you figure that out
is the best thing to do.
And I'll tell you guys, that's exactly what I do.
I have a CPA
and an accounting team that I work with
that handles everything
for my business on the tax end.
So they do my payroll,
all of my tax filings, everything,
all of my bookkeeping and all of that.
So what they do is every month
they do my books,
they reconcile everything
and they determine what my
net income was for that month.
And based off of that,
they figure out how much I need to pay myself.
So that we keep
around that 50% range
for my salary.
So I don't do any math.
I don't have to think about it.
I get an email once a month saying,
here is your profit and loss
and here is how much we are.
Here is what we wanna pay you
for payroll this month.
And so with them,
keeping their eye out
and doing the calculations,
I can be assured that
I'm not overpaying,
but that I'm
safely paying myself enough to
hopefully be within
the acceptable reasonable range
for the IRS.
So, once it comes to tax time,
the process is also a little bit different
when we're talking about S corps
versus just a single member LLC.
Once you're taxed as an S corporation
the S corp has to file
its own corporate return
which is in the form of 1120 S
that's the IRS form that you use.
One, one, two, zero S
and then the LLC is going to issue a K one
to the members.
And the K one describes the,
share the members share
of the profit and losses.
So, in a single member LLC
that's taxed as an S corporation.
The K one just allocates all of the profit or loss
to the one member.
And then the LLC is also going to need to issue a W-2
to the member slash employee.
And then the member will use
that W-2 and the K one
to prepare their personal income tax return
on form 1040
and file that
and then that's where all the taxes are paid from.
So the primary benefit
of being taxed as an S corporation
is that it really does have
the possibility of
drastically limiting your overall tax liability.
But along with that
is the additional accounting
and administrative work
and the extra
hassle of making sure you're paying yourself
the right amount through payroll.
So compared to an LLC,
it saves you in taxes,
but there's more work that goes into it.
So because of that
and because of all the intricacies
and dealing with the IRS,
it's always a good idea to make sure you're working with
a tax professional and a business attorney
to make sure the S corporation
is the appropriate move for you.
And of course to make sure
you are paying yourself correctly
and handling all the filings properly too.
That's all for this episode.
Drop a comment below and let me know what you think.
And again, don't forget to check the description
for my free downloadable guides
and check sheets too.
Thank you all so much for watching.
I'm Aiden Durham,
and I'll see you next time.
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