How S Corporation Payroll Works (In Plain English)

S Corporation payroll primarily revolves around treating owner‑officers as employees, paying a reasonable W‑2 salary, and staying current on all employment tax and filing obligations. In an S Corporation, any business shareholders who work for the company must be treated as employees and paid a fair and reasonable wage or salary. Even if a corporation has no other employees, it must register for payroll taxes if one or more of its shareholders are on the company’s payroll. This is different from how owners of a Limited Liability Company, Sole Proprietorship, or Partnership pay themselves for their work in the business. In those scenarios, the business owners take draws from the company profits. In the case of multi-owner businesses (Partnerships and Multi-Member LLCs), each owner’s share of profits and the rules for distributing ownership interests should be detailed in the company’s Partnership Agreement or LLC Operating Agreement.

Payroll management for an S Corporation essentially works the same as for other business entities with hired employees. The business must:

• Register for payroll tax accounts at the federal, state, and local levels.
• Get a workers’ compensation insurance policy.
• Decide who must be on payroll. Any officer/shareholder who performs more than minor services and receives or is entitled to compensation must be treated as an employee, receiving wages or a salary subject to the required withholdings (payroll taxes, benefit contributions, etc.)
• Determine employee pay rates, benefits, and pay periods (e.g., weekly, biweekly, or semi-monthly)
• Obtain required forms and information from new hires (e.g., W-4, I-9, state forms, direct deposit authorization)
• Have systems and processes established to ensure employees are paid correctly (for calculating pay, taxes, deductions, and benefits accurately, issuing paychecks or direct deposit, and sending payroll tax reports and deposits to the appropriate government agencies).
• Issue year-end tax forms (W-2) to each employee, and complete and submit your entity’s tax return (along with other required documentation); shareholders must also submit their individual tax returns.

Payroll requirements can be complex and confusing, no matter which type of entity you choose for your business. Here are some important things to keep in mind:

• An S Corporation needs an EIN from the IRS for federal payroll tax reporting and withholdings, and it must set up payroll tax accounts with the state (and possibly local) government as well.
• Realize that payroll taxes (such as SUI and SIT), other employment-related fees, reporting deadlines, and deposit schedules vary by state and municipality. Like any business that hires employees, S Corporations must comply with all applicable rules and regulations.
• Federal payroll tax deposits must be made through the Electronic Federal Tax Payment System (EFTPS).
• An S Corporation’s shareholders must receive reasonable wages or salaries from the business, or risk extra scrutiny by the IRS. It’s wise to use market‑based data as a guide and consider job responsibilities, hours, experience, and business size to determine shareholders’ W‑2 salaries before issuing profit distributions. Document your research method and reasons for determining shareholder wages and salaries.
• Payroll software or a payroll solutions provider that can handle all aspects of payroll management can help avoid errors, missed deadlines, and other issues that could result in fines, lawsuits, and other costly consequences.
• Some employee benefits are taxed or treated differently for S Corporation shareholders owning more than 2% of the company.
• An S Corporation must report its officers’ compensation on IRS Form 1120‑S, maintaining consistency with the totals on those employee-shareholders’ W‑2 forms.

Learn more about setting up and managing payroll:

• • What Is Payroll?
  • What Are Payroll Deductions?
  • What Are Payroll Taxes?
  • What is FUTA?
  • What is FICA?
  • Is State Unemployment Insurance Required?
  • What Is Payroll Processing?
  • Setting Up Payroll for an LLC or Corporation
  • Tax Registration: What Your Business Needs to Know
  • Payroll Mistakes That Can Hurt Your Small Business