The Payroll Tax Trap: What Every S Corp Owner Must Know

The Liberty Team
Apr 28
3 min read

Updated: May 3

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The Payroll Tax Trap....

International Taxation Experts — CPA Dallas-Fort Worth Metro Area

The Payroll Tax Trap

So, you own an S corporations. Or perhaps, you're a business owner who wants to change his or her business to an S corporation.

While S corporations do have many advantages, there are critical payroll tax implications that often go overlooked. We've seen so many S corporation owners who wind up in trouble with the IRS because they fail to take into consideration all of the payroll tax implications of owning an S corp.

Here are several things that S corp owners will want to know.

1. Owners Must Be Treated as Employees

If an S corporation owner works for the business, the IRS requires them to be treated as an employee.
That means paying themselves a reasonable salary through payroll, with payroll taxes withheld. Another consideration in all of this is to make sure that if necessary, estimated tax payments are being made if not enough taxes are being withheld.

2. Salary Is Subject to Payroll Taxes

The salary paid to the owner of an S corp is subject to:
- Social Security tax (12.4% total — half paid by employer, half by employee)
- Medicare tax (2.9% total — half paid by employer, half by employee)
The S corp must withhold taxes, pay the employer share, and file payroll tax forms like any other employer. Unfortunately, this is something that many S corporation owners overlook.

3. Distributions Are Not Subject to Payroll Taxes

After paying a reasonable salary, any additional profits can be distributed to owners.
These distributions are not subject to Social Security or Medicare taxes.
Key advantage: only the salary portion, not the full business profit, is hit with payroll taxes. However, you want to make sure you have enough "basis" in the corporation so you don't get hit with capital gains taxes on excess distributions.

Payroll Tax Issues facing S corporations — S Corporation taxation

4. Compliance Requirements

The S corporation must:

Run regular payroll (even if for just the owner).
File quarterly payroll tax reports (Form 941).
Issue an annual W-2.
File unemployment tax forms (Form 940), even if no unemployment insurance is owed.

5. IRS Scrutiny on Salary

If owners pay themselves too low a salary (or none at all) to avoid payroll taxes, the IRS can:
- Reclassify distributions as wages.
- Assess back payroll taxes, penalties, and interest.
- Dissolve a company's ability to operate as an S corporation for income tax purposes.

Summary:

In closing, as an S corporation owner, make sure that you pay yourself a reasonable salary and withhold/pay your payroll taxes.

Additionally, try your best to take distributions after salary; these distributions are not taxed for Social Security or Medicare purposes. Failing to properly report and pay payroll taxes properly can and will trigger IRS audits and penalties.

Finally, if you're an S corporation owner, we want to hear from you. Please comment below on the biggest issues you face as an S corporation. And as always, please feel free to reach out to us for any questions or concerns at 817-995-5008!

Cheers!

The Liberty Team

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