Tax audits, penalties, and fines: Oh my!
If you’re not managing your single-owner S Corp payroll properly, you could face all of these things and more.
You’re not a payroll expert, you’re a small business owner. Processing payroll for your S Corp is a necessary evil that allows you to enjoy the tax benefits of your corporation.
However, if you’re phoning in your S Corp payroll efforts, you may find yourself facing trouble down the road. With all the regulations, taxes, and more involved in small business payroll, it’s easy to make a mistake that could cost you a significant amount of funds in the future.
This post will walk you through five common missteps we’ve seen in single owner S Corp payroll and show you how to avoid making those same mistakes.
Single Owner S Corp Payroll Basics
It’s important to understand the missteps you need to avoid when processing payroll as a single-owner S Corp. Before we can provide you with that list, however, we need to first establish some baseline information. What exactly is a single-owner S Corp?
A single-owner S Corp is a tax status associated with a single-member LLC. An S Corporation allows you to pass income, losses, and deductions through the corporation to shareholders. In a single-owner S Corp, there is a single shareholder—the owner of the corporation and operator of the LLC.
Operating as a single-owner S Corporation provides you with numerous advantages:
- Avoid Double Taxation: Your S Corporation can be taxed as a pass-through entity. When you operate your LLC as a single-owner S Corporation, you are no longer considered “self-employed,” meaning you can avoid paying self-employment taxes.
- Protect Your Assets: When you operate as an S Corp, you are able to shield your personal assets from any litigation that may arise as a result of your business.
- Receive Dividend Payments: In addition to paying yourself a fair salary through your S Corp, you can also receive dividend payments. These payments are not subject to self-employment taxes and can be deducted from the cost of wages paid when calculating the income you have passed to shareholders.
Though there are a number of benefits to operating as a single-owner S Corp, you need to be aware of the consequences associated with mishandling payroll for your business. If you mismanage your S Corp’s financials, you may face significant fines and penalties, and possibly even imprisonment if your errors are egregious enough.
With the right plan in place—and help from professionals when you need it—you can manage your S Corp payroll without running into any of these hazards. Let’s take a closer look at five missteps you’ll definitely want to avoid.
1. Neglecting an Accountable Plan
The first mistake first-time single-owner S Corp owners are at risk of making is neglecting to make an Accountable Plan.
What is an Accountable Plan? At the simplest level, an Accountable Plan is a plan that enables employees to be reimbursed for expenses incurred during their work. To qualify for the Accountable Plan, expenses must be business-related and be proven within a reasonable time period. The employee must also agree to pay back any unused expense funds to their employer within a reasonable time period.
Accountable Plans are simple to establish. The rules surrounding these plans are flexible, therefore there is no reason to skip this step for your S Corporation!
This plan provides you with a simple way for you to shift the deductibility of your business expenses from the employee (you) to the employer (your S Corp). This shift lets you mitigate your personal tax liability by providing you with backup and documentation in the event of an IRS audit of reimbursed expenses.
When you create your Accountable Plan, you should include the following requirements:
- Statement of the business connection of the expense
- Guidelines for required expense documentation (e.g., itemized receipts)
- Substantiating documents for all reimbursements paid
- Rules dictating the process in an event of excess pre-payment.
2. Forgetting Health Insurance Premiums
Are you paying health insurance premiums for yourself or your family while operating your S Corp? You’ll want to pay special attention to this item.
The funds you use to pay for your health insurance premiums can count the amount paid by the company as wages in your tax returns. When you fill out your tax return, ensure that you include this information in the wages in Box 1.
Note: If you include your health insurance premiums in Box 3 or Box 5, it will be subject to social security and Medicare tax.
The main benefit of accounting for your health insurance premiums in this way is that you can then claim this cost as a deduction on your personal tax return.
3. Over- or Underusing Home Office Deductions
Next, let’s talk about home office deductions. Home office deductions allow you to deduct specific home expenses from your taxes. You can use the home office deduction if your home is your main place of business, or if you have a separate structure (like an external structure on your property) that you use for business purposes.
To qualify for this deduction, your home office must not be used for any personal purpose and must be an identifiable area, though it doesn’t necessarily need to be marked off by permanent walls.
Some of the expenses you can deduct pertaining to your home office include:
- Painting and repairs
A good way to calculate your home office deduction is to calculate the square footage of your office space in relation to the square footage of your home. You can then write off this percentage of utilities, mortgage/rent, insurance, etc. as business expenses.
The main challenge here is: Don’t get greedy! If you overestimate your home office deductions and claim too much, you may run into trouble in the face of an audit.
4. Paying Yourself Too Much (Or Too Little)
When you’re operating as an S Corp, you need to pay yourself a reasonable salary. An area where many S Corp operators run into challenges is in over- or under-estimating what a “reasonable salary” is for their role.
So, how can you set yourself up for success in terms of a reasonable salary? The best way is to set your salary based on the IRS factors relating to S Corp salaries:
- Does your position require training?
- How much time and effort is required for this position?
- How much experience is typically required for this or similar positions?
- What are the going salaries for this or similar positions?
- Does this position receive any non-salary bonus payments?
By answering these questions honestly, you should be able to set a reasonable salary for yourself. This process is all about striking the perfect balance between overpaying and underpaying yourself.
If you underpay yourself, you may run into trouble in terms of an audit—especially if you pay yourself $0 in salary per year. However, if you overpay yourself, you’ll end up paying more than you need to in self-employment taxes.
5. Missing Payroll Tax Payments
Another misstep you may make when running payroll for your single-owner S Corp is failing to make regular payroll tax payments. Once you’ve set yourself a salary, you need to process payroll to pay yourself. You can do this by following a simple, four-step process:
- Complete a W-4
- Set a payroll schedule
- Use an IRS withholding calculator to calculate payroll taxes
- Make monthly payroll tax payments
The best way to avoid missing payroll tax deadlines or accidentally miscalculating your tax amounts is to partner with a payroll provider who can help you. ConnectPay can provide you with local tax experts and connections that can help you run your S Corp payroll processes like a well-oiled machine.
Managing Single Owner S Corp Payroll with Ease
Managing single-owner S corp payroll can feel overwhelming, but it doesn’t have to be.
Understanding the missteps you need to avoid to manage your payroll effectively is an excellent starting point for ensuring that your tax season runs smoothly.
However, there’s more to running effective payroll than simply avoiding disaster. Whether you’re planning to grow your business or keep it as a single-owner entity, you may want to arm yourself with more information about how to properly manage payroll for your small business.
Explore our resource, the Connected Guide for Small Business Payroll, for more information or get in touch with a Connected Service Representative.