So you’ve made the leap and elected to become an S Corp—congratulations! Now what? One of the most crucial (and often confusing) steps is figuring out how much to pay yourself through payroll. In this episode, Danielle Hayden, CEO and founder of Kickstart Accounting, Inc., is joined by Kickstart’s Lead Account Manager, Kelsey Chester, to break it all down for you, from finding a payroll provider to understanding "reasonable compensation" and how to stay compliant with the IRS.
They also dive into the common missteps business owners make as S Corps, seasonality in your income, and why treating yourself like the CEO of your business is instrumental to its success. If you’ve ever wondered how to balance paying yourself and taxes as an owner, this episode is for you!
Key Takeaways:
- What is “Reasonable Compensation”: What factors the IRS considers to calculate a "reasonable" salary, and how to determine how much to pay yourself to stay tax compliant.
- Payroll Setup: How to set up payroll, even if you’re a solo business owner, and choose the right provider.
- Payroll vs. Owner’s Draws: The differences between payroll wages and owner’s draws, and how each impacts your taxes.
- Financial Stability: Navigate and plan for seasonal fluctuations in revenue so you can maintain consistent paychecks and avoid cash flow issues.
- Year-End Tax Planning: Avoid the mistake of waiting until the end of the year to pay yourself, and how to proactively plan to reduce tax stress.
Topics Discussed:
Payroll Setup and Payroll Providers (00:0:48 – 00:04:49)
How to Determine “Reasonable Compensation” (00:05:13 – 00:07:39)
Paying Yourself a Stable Salary and Planning for Taxes (00:09:26 – 00:12:37)
CEO Mindset and Paying Yourself What You Deserve (00:12:37 – 00:14:57)
Resources:
Episode 189 | LLC vs. S Corp: Which Is Right for Your Business?
KSA Tax Partners | Reasonable Compensation Analysis
Free Gift | ‘How Much to Pay Yourself as a Business Owner’ Calculator
KSA Tax Partners | https://ksataxpartners.com/
Preferred Payroll Provider | Gusto
*This content is not sponsored by Gusto
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Episode Transcript
00:00:00:00 - 00:00:04:14
Danielle Hayden
Kelsey, welcome back to Business by the Books.
00:00:04:16 - 00:00:06:22
Kelsey Chester
Thank you so much for having me. I'm so happy to be here.
00:00:06:22 - 00:00:27:00
Danielle Hayden
All right, today we're going to be talking about how much to pay yourself as an S Corp through payroll. So we also commonly call this a reasonable compensation. Now if you're not sure if S Corp is right for you and your business, I want you to go back and listen to episode 189, where we talk all about,
00:00:27:00 - 00:00:29:05
Danielle Hayden
LLC versus S Corp,
00:00:29:07 - 00:00:32:21
Danielle Hayden
kind of our updated stance on when to become an S Corp.
00:00:32:21 - 00:00:41:12
Danielle Hayden
But today this episode is really focused on now that we have become an S Corp, how much do we actually need to pay ourselves? So
00:00:41:12 - 00:00:48:10
Danielle Hayden
let's maybe start at the beginning for somebody who just became an S Corp. So I sent in the paperwork. I'm approved. Now, what do I do?
00:00:48:15 - 00:00:51:09
Danielle Hayden
How do I find a payroll provider? Where do I go from here?
00:00:51:11 - 00:01:15:19
Kelsey Chester
Yes. So next step is to find a payroll provider. So now that you're an S Corp, which congratulations, the IRS requires that you pay yourself what they consider to be a reasonable compensation and this compensation needs to be through payroll. So the difference between payroll versus like an owner's draw is an owner's draw you just like transfer or write yourself a check and you get that direct amount.
00:01:15:21 - 00:01:38:12
Kelsey Chester
And it's an owner’s draw because you're the owner of the business, you're not a contractor, so it won't be like a contractor payment. It's treated differently for tax purposes, but compensation is going to go through payroll. So you're withholding taxes. It's getting reported to the IRS. You're getting a W-2. That means it's actual payroll. And usually the easiest way to do this is going to be through a payroll system.
00:01:38:17 - 00:01:59:10
Kelsey Chester
So historically you've had to calculate the payroll taxes and send in the forms and do all that yourself, however payroll providers are so cost effective and time saving that there's no reason to ever do that on your own. So I know we have a few that we work with. Our preferred payroll provider is Gusto. They've been amazing.
00:01:59:10 - 00:02:16:02
Kelsey Chester
Their pricing is very reasonable. They price just a flat per month. So you can run payroll every single day if you'd like, and the pricing will always be the same, whereas some other providers they charge per payroll run. So if you have weekly payroll or even biweekly, it can tend to
00:02:16:02 - 00:02:20:03
Kelsey Chester
be up there for the price to be a lot higher than, you know, just a flat rate.
00:02:20:05 - 00:02:29:16
Danielle Hayden
And I love that Gusto is added to their platform as well. So over the years they've added on partnerships or 401(k) benefits,
00:02:29:16 - 00:02:37:04
Danielle Hayden
all of that. I know that it's very overwhelming for a business owner to think about, how do I choose and how do I
00:02:37:04 - 00:02:38:00
Danielle Hayden
get all this set up?
00:02:38:00 - 00:02:44:14
Danielle Hayden
I just want to pause to say, if you’re a Kickstart Accounting Inc. Tax Partners client, we do offer payroll set up.
00:02:44:14 - 00:02:59:19
Danielle Hayden
So you are in no way, shape or form supposed to as a small business owner, know how to set this up at the state level or how to set up Gusto. So we got you, but we want you to have all of the background information. If you need to be able to do this on your own.
00:02:59:21 - 00:03:22:12
Kelsey Chester
Yes, that's a great point. So once you found a payroll provider, next step is if the business has never run payroll before--so if you don't have any other employees or anything like that--you have to get registered for payroll tax accounts within your state. If you have employees already, maybe you're not one as the owner, but you have other employees then you should already have a payroll tax account.
00:03:22:14 - 00:03:46:06
Kelsey Chester
But if you're the first employee for the company, you'll have to get registered. So it's going to be a state withholding account. You'll need an unemployment account. And then some states have various other types of payroll, you know, local jurisdictions, any other account like disability or something like that. If your state requires that you have certain types of insurance, you have to get all of that set up within the state.
00:03:46:08 - 00:04:05:02
Kelsey Chester
I know Gusto specifically does walk you through, you know, fairly well--more than anyone else I've seen--what payroll accounts are needed. They’ll send you a link. Give you directions. However, I do find that, you know, clients that want to give that a go end up saying like, nahh, I kinda got in there and--It’s a lot--it’s too much. Would you please take it?
00:04:05:04 - 00:04:27:02
Danielle Hayden
Yeah. Okay, once we have payroll set up, and I do want to clarify one other thing, if you are already using a payroll provider to pay your employees--so you might have employees before you became an S Corp--you do not need to re go through that process. You will just add yourself to payroll as an employee. So if you're already using Gusto,
00:04:27:02 - 00:04:30:20
Danielle Hayden
you're already set up. You'll just add yourself as an employee.
00:04:30:21 - 00:04:42:16
Kelsey Chester
And when you do that, be sure that you indicate that you are at least a 2% owner of the business. It's just going to be really important for if you have health insurance or anything like that running through the business.
00:04:42:16 - 00:04:48:00
Kelsey Chester
There are certain things that are treated differently because you are the owner of the business, and the payroll system needs to know when
00:04:48:00 - 00:04:49:09
Kelsey Chester
that's the case for you.
00:04:49:11 - 00:05:12:10
Danielle Hayden
All right, we have payroll set up. Now, we have to enter in the right amount to pay ourselves. So I want to go through kind of ABC options here on how to determine how much to pay yourself. We offer a service as part of our KSA Tax Partner service, where we are offering reasonable compensation reports for each of our
00:05:12:10 - 00:05:13:05
Danielle Hayden
clients.
00:05:13:07 - 00:05:19:18
Danielle Hayden
So, Kelsey, tell us a little bit about what that compensation report is and then we can talk about the benefits of it.
00:05:19:20 - 00:05:22:00
Kelsey Chester
Yes. So what it is
00:05:22:00 - 00:05:41:12
Kelsey Chester
it shows you what your reasonable compensation amount is and to kind of dive into what the calculations are that goes into it, what what the IRS requires to go into it. It's definitely a bit more of a process. So IRS guidelines are your reasonable compensation is a factor of your area of expertise.
00:05:41:12 - 00:06:00:19
Kelsey Chester
So like, what your industry is, your proficiency in that industry and in your role. Do you have any certifications, degrees, anything like that? That can affect your compensation. Your geographic location can affect your compensation amount. All of that is entered into the calculation real quick.
00:06:00:23 - 00:06:22:11
Aubrey Philipp
Real quick, are you struggling with tax deductions or how much to pay yourself as a business owner? Get the ‘How Much to Pay Yourself as a Business Owner’ calculator and the guide to ‘The 6 Tax Tips Every Business Owner Should Know’ go to KickstartAccountingInc.com/gift to simplify your financials today. Okay, back to the show.
00:06:22:13 - 00:06:44:08
Kelsey Chester
The system that we use utilizes the country's largest database of wage information in the country to incorporate in the calculation. And that wage database includes wages by geographical location, and that is one of the requirements by the IRS. So all of that is taken care of for you. Number of employees for your business that's in there. Gross profit of your business that's included.
00:06:44:08 - 00:06:55:19
Kelsey Chester
So it's definitely a very robust and rounded calculation, one that has historically been a little bit more difficult and definitely much more of a gray area. However, we have made it simple for
00:06:55:19 - 00:07:02:09
Kelsey Chester
our clients to be able to get this report that outlines what that figure is and it is fact.
00:07:02:09 - 00:07:26:00
Danielle Hayden
That's my favorite part, because when we chose this vendor, the fact that that they were backed. It's not a random calculation that some CPA got traction. When you actually look at the IRS guidelines, this 1/3, 1/3, 1/3 calculation between salary and draws like, the IRS didn’t come out with that guidance. That's, that's not something--
00:07:26:00 - 00:07:31:17
Kelsey Chester
Nowhere in the tax code that will not hold in an IRS audit. I cannot scream it loud enough.
00:07:31:21 - 00:07:44:11
Danielle Hayden
I know! I cut you off. Tell us about why this is back. I just I love that they, they have this history with the IRS, and it is not just calculation pulled from the interweb.
00:07:44:13 - 00:08:08:21
Kelsey Chester
Exactly, I love it. It gets me excited, too, that this is different. It's not, like you said, it's not a gray area. We are so confident in the calculation that it is backed. And what we mean by that, is that if the IRS was to ever come in and audit your business and find that reasonable compensation is an issue in their audit, this company will essentially represent you to the IRS to fight that reasonable compensation.
00:08:08:21 - 00:08:25:20
Kelsey Chester
If, you know, this may have happened in the past where they have had to like represent a client. However, they have never lost, so they have never lost an IRS audit to reasonable compensation. So you can rest assured that if you were to get audited, that the issue of compensation would not be a factor.
00:08:25:22 - 00:08:39:18
Danielle Hayden
Now I have people ask all the time, well, Danielle, can't I just go on salary.com and find this information on salary.com? What is the benefit of using one of these reports over a free version of just doing a
00:08:39:18 - 00:08:41:18
Danielle Hayden
salary calculation? There.
00:08:41:19 - 00:09:04:16
Kelsey Chester
So you totally could do that. You know something is better than nothing. However, there are many other factors that go into that that analysis and that calculation. Like I mentioned before, geographical location, employees, expertise, industry, all of that. And that's all included in that. And that does matter. You know, we've tested it. We've put in different parameters for the same company, same location, same industry.
00:09:04:18 - 00:09:26:02
Kelsey Chester
If you change one or two of the factors, it does change the output of the compensation. So having the confidence that somebody with expertise has put in the parameters and just the insurance of having it be a verified report, and knowing that if there was ever an issue, that somebody is here to represent you and to support you through that to the IRS is invaluable.
00:09:26:04 - 00:09:35:04
Danielle Hayden
All right, what happens if this amazing report comes back with a amount that I cannot pay myself? What do I do?
00:09:35:06 - 00:10:02:13
Kelsey Chester
Great question. And we do see this fairly often, and it's okay. So while we know that that is a reasonable compensation, IRS guidelines say you don't have to pay yourself that full compensation amount if the business can't afford it. What it does mean is that you just cannot pay yourself any distributions unless you do. So let's just say your compensation comes back, $80,000, but you're only able to pay yourself about $50,000,
00:10:02:15 - 00:10:11:02
Kelsey Chester
that's totally fine. You can pay yourself only the $50,000 annually. You just cannot take any owner's draws because you weren't able to hit that $80K.
00:10:11:04 - 00:10:31:08
Danielle Hayden
Yeah. I really want to remind business owners, the IRS doesn't want you to put your business at jeopardy! So the IRS isn't coming in and saying you have to pay yourself no matter what. If your business doesn't have the profit, that is perfectly fine. You do not need to pay yourself the reasonable compensation, however, do not take owner’s draws.
00:10:31:10 - 00:10:54:10
Danielle Hayden
What I think we see more than anything is the tax payments. So, January rolls around, there's a slowdown in your business. You go to pay yourself and you're like, gosh, I need all $5,000. I can't pay myself $3,500 and then pay taxes on this. You really have to take the whole $5,000. So then you take a draw and then tax payments come
00:10:54:10 - 00:10:58:23
Danielle Hayden
due, and you’re like, well, I’m paying for this from the business, not my personal account. So then you pay the,
00:10:58:23 - 00:11:10:08
Danielle Hayden
the taxes. Well, we haven’t actually put anything through payroll yet and we've accumulated owner’s draws because tax payments are owner’s draws. You want to add to this?
00:11:10:10 - 00:11:24:06
Kelsey Chester
Yes, and this is something that we see fairly often is, oh, the second half of my year is it picks up and the first half of the year’s slower. So I'm pretty confident that I'll be able to pay myself the compensation by the end of the year. I'll just start towards the end and kind of play catch up. For now,
00:11:24:06 - 00:11:43:05
Kelsey Chester
I'll take the owner's draws and then we're playing a game of catch up. July goes into August, August goes into September. Next thing we know, we have three or four months to make up the full reasonable compensation amount. And while there are ways to help have some of those owner’s draw be salary on paper, it still requires a tax payment for it.
00:11:43:07 - 00:11:51:21
Kelsey Chester
Be mindful of the timing and play it conservatively of having that salary throughout the year, versus trying to play catch up towards the end of the year.
00:11:52:01 - 00:12:17:17
Danielle Hayden
I think that's the big thing. You know, we can, at the back half of the year, run owner’s drawers through payroll so that you're paying the payroll taxes on it and getting your reasonable compensation up. Things like your HSA contributions, your 401(k)contributions, these are things that will gross up your reasonable compensation. However, I don't want us waiting until the second half of the year to be, you know, putting together puzzle pieces and fixing it.
00:12:17:19 - 00:12:37:11
Danielle Hayden
And I do want to empathize for anybody who has seasonality in your business, because I get it. You know, maybe January, February, March, it's a slow time for you. That's okay. Pay yourself less during that time. That's okay. We just want to increase that that amount during our higher seasons of our business.
00:12:37:13 - 00:13:04:16
Kelsey Chester
Aside from the ups and downs, you know, when you pay yourself, when you don't, we really want you to put yourself in the CEO seat of your business. You know, you are the owner of a business, you’re the owner of an S Corporation. Pay yourself as such and treat yourself as such. And you know, if there is a lot of seasonality in your business, there are strategies to speak to that and to make sure that the cash is available, even in your downtime, for you to pay yourself regularly.
00:13:04:18 - 00:13:15:01
Danielle Hayden
I think that was a huge growth opportunity for me as a business owner, because--I'm glad you brought that up--there's not a situation where I'm, as a business owner saying, you don't have to pay me
00:13:15:01 - 00:13:27:13
Danielle Hayden
this month or this week. So I think it's an important habit and mindset shift for every business owner who's listening to really embrace that, that you deserve to be paid from your business the same way.
00:13:27:14 - 00:13:53:11
Danielle Hayden
However, it's also your responsibility to care for yourself and your employees. And so, if you don't have your bookkeeping organized, if you are not looking at regular financial reports, you didn't create a budget this year, if you are not working with the CFO team, you need to handle your business with responsibility so that you can weather through these times and treat yourself like a CEO of the business.
00:13:53:13 - 00:13:57:00
Kelsey Chester
Yep, I could not agree more. That is great advice for a business owner for sure.
00:13:57:02 - 00:14:01:03
Danielle Hayden
Okay, anything else about reasonable comp that we have not covered?
00:14:01:05 - 00:14:03:21
Kelsey Chester
Oh yeah, I think we've hit it all. Okay.
00:14:03:22 - 00:14:23:21
Danielle Hayden
I really like this topic. I know I'm an accountant, so it's easy for me to say this, but we've talked about it more over the last few years when I go and speak into other industry groups, often talk about paying ourselves. One, it's a mindset we have to pay ourselves as a CEO. We have to pay ourself as a business owner.
00:14:23:23 - 00:14:52:11
Danielle Hayden
And when you become an S Corp, you are responsible for this entity and you have the responsibility to yourself and to your employees, because if you need to dissolve your S Corp status, you cannot become an S Corp again for another five years. So it's something to take seriously. Consider and if your business has had dramatic changes, you can talk to the tax team about whether or not it would be best for you to dissolve your S Corp.
00:14:52:13 - 00:14:57:00
Danielle Hayden
However, I want us to take that situation with seriousness and gentleness.
00:14:57:02 - 00:15:13:22
Kelsey Chester
So please do go give that episode 189 a listen to see if, you know, if you are in a position where you're not an S Corp yet but considering, that will give you some guidelines around that. Hopefully that episode will help guide you in that decision. And then if you’re ready to move forward, then you come right over here and give this a re-listen so you know next steps.
00:15:13:23 - 00:15:16:14
Danielle Hayden
Yeah, absolutely. All right, that's it. Kelsey, thank you so much for being here.
00:15:16:16 - 00:15:19:20
Kelsey Chester
Thank you.
00:15:19:22 - 00:16:13:13
Danielle Hayden
I hope you enjoyed today's episode of Business by the Books. Don't forget to hit like and subscribe. This is the number one way we can help other entrepreneurs find this podcast, cause here at Kickstart Accounting, Inc., it is our mission to help entrepreneurs understand their numbers. Get access to this information, and grow and thrive in their business. So please help me, help other entrepreneurs understand their numbers so they can finally grow and thrive.