Reviewed by Andi Smiles, CPA on July 5, 2021
Reviewed by Andi Smiles, CPA on July 5, 2021
You don’t need to be a business with a bunch of employees to run payroll. If you’re the owner of a business-of-one, payroll may be an important part of both getting cash into your bank account and your tax-saving strategy. Here’s how you can run payroll for an S Corp to automatically pay yourself for a job well done.
Getting paid when you own an S Corp
Small side hustlers or newer self-employed people who use a sole proprietorship or a traditional LLC can withdraw money from their business bank account to pay themselves whenever they want. At the end of the year, they use a Schedule C to report their self-employed income and expenses, which is added to their personal tax return.
When you progress to the point where it makes financial sense to opt for S Corp taxation, you can’t just take money from the business any time if you want to get the maximum tax benefits. Instead, you use a payroll service to pay yourself employee wages and to take care of any required taxes and regulations.
Any profit you make above your regular payroll can be transferred to your account similarly to an LLC, but instead of a member’s draw that’s subject to self-employment tax, it’s a distribution that’s only subject to your regular income tax. That means profits above your payroll salary are taxed at a lower rate.
These two payment methods (employee wages and distributions) add up to your total self-employed income when running a business. But because the math and paperwork for payroll taxes can be complex, it’s best to use a payroll service or software to handle those payments for you.
Payroll services when you’re self-employed
Ahead of your regularly scheduled payday, your payroll service will deduct any required funds from your business checking account. On payday, you get a paycheck directly deposited to your personal bank account and the payroll provider takes care of everything else.
When you use a quality payroll service, it will handle both the employer and employee withholdings for any taxes, including Social Security, Medicare, federal income taxes and any required state or local payroll taxes. You just have to choose your salary and pay schedule and connect your bank accounts. As required, the payroll provider will file forms with the IRS and your state and remit any required payments.
If you sign up for a membership with Collective, you get a membership at leading payroll provider Gusto, one of Collective’s partners. Gusto is an online-first payroll service that makes it easy for you to get your payroll set up so you can get back to work making money. Gusto also integrates with your complementary Quickbooks Online subscription for easy payroll accounting.
Choosing your salary and pay schedule
While your payroll provider will take care of tax calculations for you, it’s up to you to decide your pay schedule and salary. It’s important to pay attention to IRS rules and think about your regular expenses when making these decisions.
You have to decide on a “reasonable” salary for your paycheck for the work you do. While you may think a $1 salary is reasonable, as it makes your self-employment taxes really small, the IRS probably wouldn’t let you get away with that. If you underpay yourself, you could be subject to stiff penalties.
Reasonable compensation is not a set standard, but rather based on facts and circumstances. It usually shakes out to be 35% to 45% of your net revenue, but you should consult your tax professional on an appropriate range to set your annual salary. Here’s the official IRS publication on compensation for S Corp officers.
You can pick any pay schedule you want that’s supported by Gusto. If you prefer weekly, every other week, twice per month, or monthly payroll, for example, any of those are just fine. (I use a weekly pay schedule myself.)
A little work on payroll can save you thousands in taxes
Getting started with an S Corp does take some work, but that work is nothing compared to the tax savings you’ll likely experience. Collective members save an average of $16,845 in taxes every year. That’s more than $1,400 a month that the average Collective member gets to keep in their bank account instead of handing it over to Uncle Sam.
You work hard for every dollar you earn, so you shouldn’t just stick with the default tax situation. Just as you put in a little extra hustle for your business to succeed, it’s worth investing efforts into your business finances to optimize your results.
Once you’re up and running, your biggest problem is going to be deciding what to do with that extra $1,000 or more every month. That’s a great problem to have.
Eric Rosenberg is a finance, travel, and technology writer in Ventura, California. He is a former bank manager and corporate finance and accounting professional who left his day job in 2016 to take his online side hustle full-time. You can connect with him at Personal Profitability or EricRosenberg.com.