If you own an S Corporation and work in the business, your salary is not something you should set once and forget about.
September is a smart time to review it.
By the time Q4 begins, your business may look very different than it did in January. Revenue may have increased. Your responsibilities may have changed. You may have hired employees, taken on new clients, or started taking larger distributions.
If your S Corp owner salary has not changed along with the business, it may be worth another look.
The IRS Cares About More Than Your Distribution Check
One of the biggest benefits of an S Corporation is the ability to receive both wages and shareholder distributions.
But there is an important rule attached to that benefit.
If you provide more than minor services to your corporation, the IRS generally considers you an employee. Payments for those services must be treated as wages to the extent they represent reasonable compensation. The IRS can also reclassify distributions as wages when it determines an owner was underpaid for the work performed.
That makes your S Corp owner salary more than a personal budgeting decision. It is a payroll and tax compliance issue.
Our earlier guide, Getting Paid: A Guide for Small Business Owners, explains how compensation differs depending on your business structure.
Reasonable Does Not Mean Picking a Convenient Number
There is no universal salary amount that automatically satisfies the reasonable compensation requirement.
The IRS looks at the facts surrounding the business and the work performed. Factors can include your experience, responsibilities, hours worked, the services you personally provide, compensation paid to other employees, and what similar businesses pay for comparable work.
That is why a salary that made sense two years ago may not make sense today.
For example, imagine you started the year handling sales and administration for a small company. By September, you are also supervising employees, managing major customer accounts, and overseeing daily operations.
Your job changed.
Your compensation may need to change with it.
Three Q4 Warning Signs Your Salary Deserves Another Look
Before the fourth quarter starts, consider whether any of these situations apply:
- Your business profits increased significantly this year
- You are taking substantial distributions while receiving a relatively small paycheck
- Your role, workload, or responsibilities have expanded since your salary was established
None of these automatically means your salary is wrong. They are simply good reasons to review the number with your accountant or tax professional.
A useful external resource is CSI Accounting & Payroll’s discussion of how owners should approach compensation. Their guidance also emphasizes periodically reviewing owner pay rather than assuming the original amount will remain appropriate forever.
Why September Is Better Than December
Waiting until the final payroll of the year can create unnecessary pressure.
If you discover that your S Corp owner salary needs to increase, you may need to account for additional payroll taxes, withholding, cash flow, and payroll processing before December 31.
Reviewing compensation now gives you more room to plan.
It also gives your accountant time to look at year to date profit, distributions, expected year end income, and the actual work you perform for the company.
That does not mean you should suddenly create a large payroll adjustment simply because Q4 is approaching. Your salary should still be based on reasonable compensation for your services.
The point is to make the decision intentionally rather than discovering a problem during year end tax preparation.
Alabama Owners Have State Payroll Responsibilities Too
For Alabama businesses, changing an owner’s wages can also affect state payroll withholding.
Alabama employers are responsible for withholding Alabama income tax from wages subject to Alabama income tax, along with handling the appropriate employer withholding filings.
So if your accountant recommends adjusting your salary, the change should flow through payroll properly. Simply transferring additional money from the business account to your personal account does not automatically turn that payment into payroll wages.
Your federal and Alabama payroll records should reflect what actually happened.
Do Not Forget the Other Pieces of Owner Payroll
Salary is not the only year end item S Corp shareholders may need to review.
For shareholders who own more than 2 percent of the company, certain health insurance premiums paid by the corporation may need to be included in Form W2 wages for income tax purposes. The IRS has specific reporting rules for these benefits.
That is another reason September is a useful checkpoint.
You still have time to review payroll records, benefits, distributions, and compensation before year end reporting becomes urgent.
Give Your S Corp Salary a September Checkup
Your S Corp owner salary does not have to change every quarter.
But it should still make sense.
If your business has grown, your responsibilities have expanded, or your distributions have changed significantly, reviewing owner compensation before Q4 can help prevent an unpleasant conversation at tax time.
Payroll Complete can help make sure any approved salary changes are processed correctly through payroll, while your accountant or tax advisor helps determine what compensation is appropriate for your specific situation.
A quick review now can make December much easier.