The tax situation of a business owner is almost always complex, and it changes regularly. As of 2009, corporations, S-corps and LLCs must pay employment taxes on behalf of their owners. Those owners do not necessarily have to be paid at all, but if they are paid they must receive regular and reasonable compensation. Thus, whether or not you must pay yourself payroll depends on your situation. Always seek qualified advice from an attorney or accountant when determining your tax and payroll liabilities.
What Is Payroll?
Payroll technically refers to the entire amount of cash that employers pay to and on behalf of employees. It is typically subject to laws about timely and regular payments to employees, amounts of withholding and tax payments, specific base wages and other regulations designed to protect employees. Single-owner businesses may be exempt from these requirements in some states, but not in others; Texas requires monthly or bimonthly payments to all nonpublic employees, for example.
What Is Subchapter S?
The owner of a corporation can elect to file with the IRS as a subchapter S corporation for tax purposes. At the state level there is no difference between this "S corp" and a standard corporation, called a "C corp." However, S corporations do not pay income tax themselves. Rather, the owners of the corporation pay personal income taxes when they receive payouts from the company.
A corporation's single owner may choose to take assets from the business in several ways. He can receive a loan, take profits as a distribution and be paid a salary. Court rulings have specified that if an S-corp owner takes money out of the company in any manner, that money must be treated as salary up to the amount of "reasonable compensation" for the work he has done, measured against the market rate for his position. This salary is subject to all normal payroll taxes.
Corporate Owner Salary
Previously the owners of LLCs and some S corporations could elect to pay tax on self-employment income rather than take a salary, but a 2009 ruling has eliminated this option. Distributions that are subject to the reasonable compensation limit must be treated as salary, not self-employment income and therefore taxed as payroll. However, if the company has no earnings for the owner to draw, she may not have to draw any distribution. S corporations can be created with corporate by-laws that specify the owner may draw "up to" a certain salary, thus allowing her to draw a lower amount out of the business.
- IRS.gov: Internal Revenue Bulletin: 2007-39
- Tax Trusts and Estates Law Monitor; S Corporation Owners Must Take Reasonable Salary; Steven M. Saraisky; February 2011
- IRS.gov: S Corporation Employees, Shareholders and Corporate Officers
- Ballard Spahr; Disregarded Entities Are Now Responsible for Their Own Employment Taxes; July 2009
- Attorney Chris Beer; Ironmark Law; Seattle, Washington
- Texas Workforce: Summary of Texas Payday Law
Evangeline Marzec is a management consultant to small high-tech companies, and has been in the video games industry since 2004. As a published writer since 1998, she has contributed articles and short stories to web and print media, including eHow and Timewinder. She holds a Master of Business Adminstration from Thunderbird School of Global Management.