If you perform services for the S corporation and are also a shareholder, the S corporation must pay you a wage. It is your choice whether you take compensation as an employee or independent contractor. As an employee, the S corporation withholds taxes from your wages and submits the money to the Internal Revenue Service on your behalf. As an independent contractor, the S corporation pays you, but you are responsible for paying taxes.
Decide an amount for your wages and payment method. If the company pays you as an employee, download and fill out Form W-4, Employee Withholding Certificate. File the W-4. If the company pays you as an independent contractor, download and fill out Form W-9 for independent contractors. Like the W-4, the company maintains the W-9 for its records.
Draft an employment letter for approval by the other S corporation shareholders. Maintain the pay agreement as part of the corporate documents. This is particularly important should a legal issue arise or if the IRS needs supporting documentation on employment information of corporate officers.
Calculate how many withholding allowances you want to claim on the W-4. The greater the number of allowances you claim, the fewer taxes the S corporation withholds from your paycheck. In general, claim one allowance for yourself and one allowance for each applicable circumstance defined by the IRS. Usually the number of allowances equals the number of exemptions you take when you file your tax return using Form 1040. If you filled out a W-9, the S corporation does not withhold taxes from your wages. As an independent contractor, you are responsible to make estimated income tax payments. In addition, you are responsible for self-employment taxes of 15.3 percent, which is your contribution to the Federal Insurance Contributions Act (FICA) tax.
Deduct federal income taxes from your paycheck as an employee. The number of allowances and expected deductions and credits determine your tax rate. Calculate and deduct the FICA tax from your paycheck. FICA tax is 7.65 percent of your income, which represents 6.2 percent for Social Security and 1.45 percent for Medicare (as of 2011). The S corporation is responsible for the other half of the FICA tax. There is an income limit of $106,800 for Social Security tax. If you earn above this amount, the S corporation no longer deducts the tax from your wage. The Social Security limit also applies to self-employment taxes. There is no income limit for Medicare.
Deduct any other pretax items from your paycheck as an employee. Examples of other deductions include 401k contributions and medical and life insurance premiums.
Following the calendar year, an employee receives a W-2 that he uses to file his taxes. Independent contractors receive Form 1099. An S corporation with employees must file Form 941 quarterly and make federal payroll tax deposits via the Electronic Federal Tax Payment System. The IRS recommends making payroll deposits as soon as the S corporation pays its employees. The S corporation is also responsible to pay the Federal Unemployment Tax Act (FUTA), which is unemployment benefit insurance for unemployed workers. Employees of the S corporation are not responsible for the FUTA tax.
An unusually low wage as an employee-shareholder raises red flags with the IRS. Your wage should be reasonable based on the services you perform for the S corporation.