Pays Less Taxes Your S corp salary: how a fair wage lowers your tax

An S corp owner who works in the business is also its employee. Your paycheck from the company has Social Security, Medicare and income tax taken out, like anyone else's, and you get a W-2 each January.

What's left after the salary and the other costs is profit. It passes to you on a K-1, and you pay income tax on it either way. When you take it out as a distribution, it carries no Social Security or Medicare tax. That gap in payroll tax is the S corp saving.

Here's a made-up owner with $140,000 of profit before paying themselves. We'll keep income tax out of it for now and look only at Social Security and Medicare.

• As a sole owner: self-employment tax is 15.3% of 92.35% of the profit. That's about $19,780.
• As an S corp with a $70,000 salary: payroll tax is 7.65% from the company and 7.65% from the paycheck, or $10,710 in all.
• The difference: about $9,070 a year.
• What comes off it: a payroll service, the S corp's own tax return, and in some states an extra state fee or tax.
• What else moves: the QBI deduction gets smaller, because a salary doesn't count as business income. Our worked example counts that in.

Your numbers will differ. On the call we run them with your real profit and a salary that fits your work.

The IRS asks for reasonable pay for the services you provide. It looks at the same things any employer would.

• Your training and experience.
• Your duties and how much time you spend on the business.
• What the business pays others who do similar work.
• What similar businesses pay for the same services.
• How and when bonuses are paid, and the history of distributions.

A useful test is what you'd have to pay someone else to do your job. If you split your time between roles, such as selling, managing and doing the work, each role can be priced separately. Government wage surveys, like the Bureau of Labor Statistics occupation data, give you a starting range.

Set the salary too low and the IRS can recast some distributions as wages, then charge the missing payroll tax plus penalties. A salary you can explain protects the whole saving.

We set payroll up with you. After that, each payday runs through the payroll company you choose, and you approve it.

• Make sure the company has its employer identification number.
• Pick a payroll provider.
• Open your state withholding and unemployment accounts.
• Set the salary and how often you're paid.
• Run each payday. The provider files Form 941 every quarter and the W-2 and Form 940 by January 31.

If the S corp pays your health insurance and you own more than 2%, the premiums go on your W-2 as wages. You can then usually deduct them as self-employed health insurance on your own return.

Your salary also sets your retirement limits. In a Solo 401(k), the company can add up to 25% of your W-2 pay. So a salary that's too low shrinks the plan, and that's one more reason to pick the number with care.

How low can my salary go? It needs to match what your job would cost to hire out. We help you find a figure you can explain with your duties, your hours and what others are paid for that work.

I've paid myself only owner draws this year. Can I fix that? We can often start payroll before December 31 and pay a fair salary for the year through the last paydays. The sooner you start, the easier it is.

Who runs payday? The payroll provider you pick. We set it up with you, and you approve each payroll.