As an officer in an S corporation, your work is integral to your company's success. This is especially true with solopreneurs who opt to structure their business as an S Corp for tax purposes.
Part of handling it all correctly is ensuring you are structuring your compensation in a way that is fair for you and in line with applicable tax laws.
What Are the Rules for Compensation and Bonuses?
The owner of an S corporation is permitted to draw a reasonable salary for their work in the company. What this means is that your paycheck should be comparable to what any other employee would be paid for the services you provide.
For instance, if you are the CEO of your company, your paycheck should be comparable to what a hired CEO would be paid to run a company like yours. There is a great deal of leeway regarding how much that should be. Factors like the size and location of your business, current economic conditions, and employee qualifications all come into play.
As a result, there are no strict numbers or guidelines for setting up a compensation structure. As long as the company doesn't violate fair labor laws, you can set up whatever sort of package makes sense for you.
This compensation structure can include a mix of salary, bonuses, and distributions. Bonuses can be one-time windfalls or regular parts of your compensation structure.
Limits on Bonuses
Bonuses are personal income that create a net reduction in the corporation's income. For instance, if your company has receivables of $300,000 per year, and you take a $150,000 salary and a $50,000 bonus, that leaves the corporation with $100,000 in net income.
If the combination of bonuses and salary is too high, this can expose the business as a whole to allegations that the company is unfairly shielding funds from creditors.
To avoid potential issues, many people who organize as S corporations opt for a 60/40 or 50/50 compensation plan, where half their income comes from salary and half from distributions of corporate profits, with bonuses only used on a limited basis.
Every company is different, and it's best to talk to an expert in your field to ensure your compensation model adheres to tax laws while giving you the maximum tax benefit.
Tax Implications of S Corp Bonuses
The way that bonuses are taxed is important. Any bonuses that employee shareholders receive are considered taxable compensation. Because the S Corp itself is exempt from paying corporate taxes, employee shareholders must pay both the income and employment taxes on any bonuses they receive.
At this time, these taxes include Social Security and Medicare. The Social Security tax is assessed at 12.4 percent of bonus earnings up to $117,000 per year. Medicare is taxed at 2.9 percent of an employee-shareholder's income, including bonuses.
Making Payroll Easy
There is no one right way to run your business. What makes sense for your company will be as unique as your products and services.
If you need assistance with understanding the tax obligations of your Subchapter S Corporation or any other HR and payroll services, contact CAVU HCM today for expert guidance. CAVU's simple but powerful payroll software helps you manage your compensation and tax needs with ease.