Mastering S Corp Payroll: A Guide to Paying Yourself Right

If you're self-employed, own your own business or a contractor who's transitioned into an S Corporation—or thinking about it—understanding what is payroll and how to pay yourself properly is key. Payroll isn’t just about taking home a paycheck; it also involves complying with IRS guidelines to keep your S Corp running smoothly. Using Lettuce to manage payroll can help you stay compliant with IRS regulations and streamline the process effectively. Follow along in this guide as we explore the fundamentals of payroll management and discover how Lettuce simplifies paying yourself and maintaining your business’s stability. 

Why Payroll Matters and Why an S Corp Needs It

As the owner of an S Corp, understanding how to pay yourself properly is not just a matter of receiving income but also ensuring you comply with the IRS’s rules. Payroll plays a vital function in the effective operation of S Corporations. One of the biggest tax benefits to owning an S Corp is the ability to split your income into two buckets: salary, which is liable to employment taxes, and owner’s distribution, which is not. More on that later.

Many owners ask, “Do I need to run payroll in an S Corp?” The answer is yes. As an owner, you often wear two hats—one as the employer and the other as the employee. The IRS requires that S Corp owners give themselves a fair paycheck; getting this right can help you maximize tax advantages and avoid penalties.

Payroll typically refers to the process of paying employees, which includes calculating gross pay, taxes, and deductions. However, in an S Corporation, it’s crucial to run payroll to ensure you pay yourself a reasonable salary. This helps prevent owners from taking only distributions to avoid employment taxes and facing potential IRS scrutiny.

While the process might seem overwhelming, Lettuce simplifies payroll by automating the distribution of each payment to your S Corp, paying quarterly taxes, and ensuring compliance with IRS regulations—all of which makes it easier to focus on running your business.

How Do I Pay Myself in an S Corp?

As the owner of an S Corp, you pay yourself two ways—and it’s key for maximizing tax benefits:

1. Reasonable salary: A salary in an S Corporation is subject to payroll taxes, such as Social Security and Medicare, and the IRS mandates that it be "reasonable," based on industry standards and the company's performance.
2. Distributions: This is profit you take from the business beyond a salary and isn’t subject to payroll taxes.

How reasonable salary is determined

For your salary to be deemed reasonable in the eyes of the IRS, it must be in line with what other workers in your field and circumstances are earning. This fairness ensures that you are compensated appropriately and equitably compared to your peers.

Lettuce follows a rule of thumb by automatically allocating a percentage of your income to payroll based on several factors like projected income, net income, statistical data about your industry, and IRS guidelines to ensure compliance and tax efficiency.

Step-by-Step Guide to Managing Payroll as an S Corp

Step 1: Determine Your Salary

Reasonable salary is calculated using industry benchmarks, such as your industry experience, and assessing the financial health of your business. You can reference tools like the Bureau of Labor Statistics to find competitive wages in your field.

This process can get complicated that is why Lettuce simplifies and automates it for you. Lettuce automatically allocates a portion of your income to payroll, based on general IRS guidelines. This ensures compliance and tax efficiency, while also factoring in your business's net income to reflect true profitability. Lettuce is constantly analyzing your business financials to optimize your salary and tax withholdings, striking the perfect balance between compliance and efficiency.

Step 2: Getting Started with Payroll in Lettuce

If you’re managing an S Corp, payroll is essential, and Lettuce makes it simple and effortless. Lettuce's platform guides you through setting up an automated payroll plan, integrating with Gusto behind the scenes for payroll services, with no manual set-up required. This ensures you stay on top of both federal and state payroll tax requirements, making compliance and set-up easy and stress-free.

Step 3: Pay Taxes

Lettuce automatically prepares and processes your payroll taxes, including FICA and Medicare, and handles important forms like IRS Form 941. This takes the stress out of staying compliant with quarterly filings.

Step 4: Plan for Distributions

You can take distributions as the business profits grow, but it’s crucial to maintain a clear separation between salary and distributions to avoid IRS scrutiny. Lettuce helps automatically balance these two streams without confusion.

Curious if an S Corp is right for you?

Try the Lettuce Tax Calculator to see how much more you can take home each year.

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Common S Corp Payroll Mistakes

Paying yourself through an S Corp comes with distinct tax benefits, but it can be hard to get it right when you’re managing the process on your own. Here are the most common payroll mistakes to note.

Unreasonably Low Compensation

One of the most common errors is paying yourself a salary that's significantly below industry standards. This could raise suspicions with the IRS that you're trying to avoid payroll taxes. Lettuce helps you determine a reasonable salary based on your industry, ensuring you're compliant and avoiding unnecessary scrutiny.

Disproportionate Distribution

Taking large distributions while keeping your salary artificially low can signal an attempt to dodge payroll taxes. With Lettuce, you can clearly separate salary and distributions, making sure each is handled correctly and within IRS guidelines.

Neglecting a Salary

If your S Corp is profitable and you're not taking any salary, it can trigger IRS concerns. Lettuce ensures you're drawing a reasonable salary and keeping everything in check with tax regulations.

Inconsistent Payments

Irregular salary payments or distributions that don't follow a typical payroll structure can raise red flags. Lettuce simplifies this process by providing clear, consistent payroll schedules to keep your records clean and compliant.

Mixing Personal and Business Expenses

Paying for personal expenses through your S Corp can lead to IRS questioning. Lettuce helps you keep business finances separate, ensuring you don’t unintentionally mix personal and business expenses by automatically setting you up with a free business bank account for all your business transactions, including a debit card, depositing invoices, running payroll, and making tax payments.

Lack of Documentation

Failing to maintain proper records that justify your salary levels can cause trouble in the event of an audit. Lettuce keeps detailed records of your payroll and distribution decisions, ensuring you're prepared if the IRS comes knocking.

Pay Yourself Like a Pro with Lettuce

Managing payroll doesn’t have to be complicated. As an S Corp owner, paying yourself a reasonable salary is a must for staying compliant with IRS rules, and Lettuce makes this process easy and efficient.

Explore Lettuce today to automate payroll, maximize your tax benefits, and focus on growing your business without worrying about compliance. If you're not already an S Corp, see how much you could save with our free tax calculator.

For more insights on how S Corps work, how you save, and how Lettuce makes it easy, check out our free recorded event on S Corp 101.