When paying shareholder-employees, S corporations may classify outflows as either salary expense or shareholder distributions. Classifying payments as distributions, on the other hand, doesn’t reduce the business’s taxable income, but most distributions are typically payroll-tax-free.

Does an S Corp have to pay payroll taxes?

An S corporation must pay employment taxes on employee pay, including withholding and reporting federal and state income taxes, paying and reporting FICA (Social Security and Medicare) taxes, worker’s compensation taxes, and unemployment taxes.

What are distributions to shareholders?

Shareholder distributions, also known as dividends, represent money paid to stockholders periodically throughout the year. In a small business, the stockholders may be limited to one or a few owners. The owners receive income from the company through the form of shareholder distributions.

How does a shareholder get paid as an employee?

If you want to pay a shareholder for work the shareholder has performed as an employee, you pay the shareholder just like you pay any other employee. This means, if you’re using a payroll service like ADP or Paychex, that you add the shareholder-employee to the payroll system and pay the shareholder-employee just like any other employee.

Can A S corporation stop paying shareholder wages?

In this case, you can probably also stop or pause shareholder-employee payroll. You don’t want to be in situation where you, for example, invest an additional $20,000 into your S corporation so you can pay yourself another $20,000 of wages.

Do you have to pay shareholders reasonable compensation?

Now, I need to tell you that you are required if you operate as an S corporation to pay shareholders reasonable compensation. The Subchapter S election acceptance letter you get from the IRS makes this point in firm, almost threatening language.

What happens if you don’t pay a shareholder?

Accordingly, if you haven’t paid out anything to a shareholder—if all the profits for the year still sit there in the company checking account—you don’t need to worry about not having reasonable compensation for a shareholder. By the way, a quick caveat: This “no distributions to re-categorize” scenario isn’t a long-term solution.