Updated June 30, 2020:

S corp how to pay yourself is an important thing to know if you are a shareholder in an S Corp but also conduct work for the business.

The reason for this is because the Internal Revenue Service (IRS) closely monitors transactions that occur between the S Corp and its shareholders, particularly those shareholders who conduct substantial services for the business. Therefore, if you are in fact doing substantial work for the S Corp, then the IRS expects you to pay yourself a “reasonable” compensation for that work. Along with a reasonable compensation, you can also receive dividends from the S Corp; these dividends are not taxed.

While dividends aren’t taxed, any compensation you receive is taxed at the typical personal tax rate. For this reason, most shareholder-employees would prefer to be paid strictly through dividends as opposed to receiving compensation, as they can avoid paying taxes if only receiving money through dividends. But before you choose to go this route, remember that the IRS will take notice. So it is best that you pay yourself a salary as well as dividends to avoid being questioned by the IRS.

Substantial Services Performed by a Shareholder

If you do substantial work for the S Corp and you are also a shareholder, then you will be considered an employee too, i.e., shareholder-employee. This means that the S Corp has to pay you a salary. You can choose to receive a salary as either an independent contractor or employee.

If you choose to be considered an employee, then the business will be required to withhold taxes from any wages and submit the withholdings on Schedule K-1 to the IRS on your behalf. If, however, you choose to operate as an independent contractor, then you are responsible for paying taxes.

Factors to Consider When Paying Yourself

There are several factors you should consider when paying yourself for the work you do. Be sure to distribute some compensation as dividends. While you need to pay yourself a reasonable salary, you can still earn money through dividends, thereby reducing your taxes to an extent. Combine distributions and wages if you perform some functions for the business. Remember that the pay should be appropriate to the level of work being performed.

Some factors to think about include the following:

  • Consider splitting your income through dividends and wages. For example, if you want to pay yourself $200,000, then perhaps you can receive compensation of $100,000 and dividends of $100,000.
  • Pay yourself equivalent to what others in the industry would be making for that specific work.
  • Create an employment letter that will be approved by all of the S Corp shareholders.
  • Determine how many allowances you would like to claim on your W-4. Remember that the more allowances you claim, the fewer taxes that will be taken out.
  • If you fill out W-9, then the S Corp won’t withhold taxes from your wages, so you will be required to pay taxes yourself. Further, if you operate as an independent contractor and not an employee of the S Corp, you will need to pay taxes yourself.
  • Deduct federal income taxes from your paycheck, along with other pre-tax items such as medical/life insurance premiums and 401k contributions.

Applicable Forms for S Corp Businesses, Employees, and Contractors

The S Corp must file Form 941 on a quarterly basis and make federal payroll tax deposits, which can be done online through the Electronic Federal Tax Payment System. If the shareholder elects to operate as an employee, then he or she will need to file taxes on a W-2. If choosing to operate as an independent contractor, then Form 1099 will need to be filled out. The IRS generally recommends S Corps to make payroll deposits once the business pays its employees.

The business is also responsible for paying fees through the Federal Unemployment Tax Act (FUTA), which is a specific kind of unemployment benefit insurance for unemployed workers of the company. Employees are never responsible for paying this type of insurance.

If you need help learning more about S Corporations or how to pay yourself, along with what constitutes reasonable compensation, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.