3 Ways to Take Money Out of an S Corporation - Paying Shareholders

business best practices s corporations tax tips Nov 29, 2022
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Unlike Single Member LLCs and Partnerships, S Corporations pay owners via payroll.  

In fact, it is a requirement of an S Corporation to pay the shareholders of the S Corp a "Reasonable Salary".

Payroll is just one of the ways for shareholders to take money out of an S Corporation.

Before we jump into the other ways, let's take a step back and cover where you start.

1. Setup Accounts in Bookkeeping Software

As with any entity, we start in the Equity section of their bookkeeping.

Each shareholder needs a Shareholder's Equity account with sub accounts for Shareholder Contributions and Shareholder Distributions.

As payroll is added to the mix, payroll warrants its own salary, payroll tax, payroll fees, liability accounts and more depending on what benefits you run through payroll.

2. Three ways to take money out of the S Corporation

There are 3 common ways to take money out of the S Corporation.

Salary

The first way to take money out of an S Corporation is via payroll.

Paying shareholders a "Reasonable Salary" via payroll is a requirement for S Corporations.

We highly recommend using a payroll company like Gusto to service an S Corporation payroll. 

Gusto withdraws taxes, remits them and files all quarterly and annual reports with the IRS and the state as part of their service.

If you are already using another payroll service like ADP or Paychex, you are good to go. 

Why outsource for one employee? Payroll mistakes are common and costly! The monthly payroll fees are a small price to pay compared to penalties and fines when mistakes are made.

Hiring a payroll service is a cost of doing business.

We cover more about salary below.

Distributions

The second way to take money out of an S Corporation is a cash distribution to owners.  If you have more than 1 shareholder, distributions must follow ownership percentages.

For example, if you have two - 50% owners, distributions should be equal to each shareholder.

What is a distribution? Distributions are simply a cash transfer from the business bank account to personal bank accounts of shareholders.

Distributions can be made via ACH, Zelle, check, etc. The method doesn't matter. It's simply a transfer of funds categorized as a Shareholder Distribution.

Note that Shareholder Distributions in S Corporations are NOT dividends. 

No 1099-DIV is issued by the S Corporation.  Salaries are reported on the W2 and Shareholder Distributions are reported on the tax return.

Loans

The third way to take money out of an S Corporation is via a Shareholder loan.  

Note that if you are doing a Shareholder loan, it should pass a fact and appearance test.

Documentation is your friend!  

2. Determine Reasonable Salary

There are many factors that go into what a reasonable salary entails. 

Many will tell you the salary must fall within a percentage of pre-wage net income.

If your salary falls within 40-60% of pre-wage net income, you are off to a good start, but don't stop there.

In addition to looking at a straight percentage, there are other factors to consider like the market rate for similar positions at other companies, what percentage of time you spend in your business, etc.

Is what you are paying yourself reasonable?

Simply, the burden of proof is on the shareholder to prove this statement is true in the case of an audit.

3. Keeping business books and documentation

Keeping business finances separate from personal finances is a must for S Corporations.

Not doing so can put you at risk of losing liability protection and your S Corp status. 

Whichever bookkeeping software you prefer, go with it.

We use QuickBooks Online with all our clients, but other software like Xero and WaveApps are available if you prefer them for cost or ease of use.

Gusto integrates seamlessly with QuickBooks Online and records your payroll for you via Journal Entries - done for you.  Another reason we like it.

Receipts, documentation, and keeping your business and tax filings current is a must.

Understanding the tax differences in the ways you take money out and put money into your business is key to effectively implementing tax-saving strategies.

We have an eBook called S Corp, Now What? for new and seasoned S Corp shareholders that provides more detail and is available at no cost to download now.

4. Get help implementing tax-saving strategies in your S Corporation

If you elected S Corp for your business, you did so with the idea that tax-saving opportunities exist for S Corp owners.

However, if you don't implement those tax-saving strategies, you are paying for the admin of the S Corporation structure and missing out on the tax savings.

We have a package where we offer white-glove service to help S Corporation owners implement tax-saving strategies.

If you would like some help with implementation, let us know

Note: if you are a Partnership, Sole Proprietorship, or Single-Member LLC, how you take money out of your business differs.  

Need help from a CPA with your taxes, business setup or tax strategy? Send us an email at [email protected] or book a call.

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Author:

Julie Merrill is a Certified Public Accountant, business and tax strategist and has over 25 years of experience working in large to small companies. She currently owns and runs her own tax practice.

Disclaimer:  The information provided in this post is for information purposes only and is in no way intended to be tax or legal advice.  For personalized tax and legal advice, seek counsel with your legal team or tax advisor.