Not every one-person corporation pays or even can pay an annual salary of $40,000 to the shareholder-employee. But a salary of $40,000, it turns out, is roughly the average salary paid by a single-shareholder S corporation to its shareholder-employee.
Accordingly, this post describes a quick-and-dirty approach to simply, easily and correctly prepare payroll for a one-person corporation when the shareholder-employee makes $40,000.
Note: If you’re here looking information about the 2016 edition of our $10 ebook, “Five Minute Payroll System, ” scroll down to the bottom of the page.
Step 1: Set a Reasonable Salary
Step 1 is setting a reasonable salary. And so let me issue a caution here.
While I’ve arbitrarily set the salary to $40,000, you absolutely must verify the salary you pick for a one-person corporation is reasonable.
You may want to read an ebook I’ve written, “Setting S Corporation Salaries” or confer with your tax adviser if you’re not sure about your salary. You may also want to review the average S corporation salaries data we provide at our “S Corporations Explained” website.
By the way, you may very well conclude that a $40,000 annual salary is appropriate. And if that’s the case, you can use the numbers and examples provided here as your own.
Step 2: Calculate the Payroll Amounts and Taxes
Once you know the correct salary to pay yourself as a shareholder-employee, you calculate the payroll amounts and taxes.
For purposes of the method described here, you think in terms of quarterly payroll amounts and taxes.
Rather than a $40,000 annual salary, for example, you think in terms of a $10,000 a quarter salary.
Calculating the employer’s payroll tax burden
Your corporation pays a 7.65% Social Security and Medicare payroll tax. If your S corporation pays you payroll of $10,000 a quarter, that amount equals $765 obviously.
Calculating the employee’s payroll and income taxes
You (the employee) also need to pay a 7.65% payroll tax as an employee. If your corporation pays you payroll of $10,000, that’s another $765.
You also need to pay federal income tax. Rather arbitrarily, I’m going to set the federal income tax to $750 a quarter, so over the year, you’ll have paid $3,000. But in many situations where $40,000 is the appropriate wages amount, this amount of federal income taxes will pay the federal income taxes.
Calculating the net wages amount
With a $10,000 a quarter salary and the preceding payroll taxes, you need to pay yourself $8485 each quarter in net wages.
Note: The corporation will hopefully disburse more than $8485 a quarter to you. But the first $8485 will count as wages. The checks you write after reaching the $8485 threshold will represent shareholder distributions. For example, if you also write a $1000 or $2000 check each month payable to the shareholder and this amount is not payroll, you categorize that disbursement as a distribution.
Step 3: Preparing the Federal Quarterly Payroll Tax Return
With a $10,000 quarterly payroll, you don’t need to make next-day or next-week deposits of payroll taxes you’ve withheld from employee payroll checks.
Instead, you can deposit the taxes when you file the quarterly 941 payroll tax return, which you can download from the Internal Revenue Service’s web site (click here to grab form).
I’ve included an image below that shows you what a completed 941 looks like when you’re paying a shareholder-employee $10,000 a quarter and withholding $750 a quarter in federal income taxes. You of course enter the employer identification number, name and address information with your actual information.
You also need to check the right “Report For This Quarter” box in the upper right corner of page 1 (check January, February, March for the first quarter, for example). And you need to sign the return. Note also that your state and whether or not you send in a payment determines which address to send the form to. But all the other information shown on the 941 in boxes 1 through 15 and on the 941-V would match what I’ve plugged in here.
After you complete and sign the 941 form, you write your check for $2,280 and then mail the 941 return, including the 941-V coupon, and your check to the appropriate address.
Tip: If you want more information, you can get that information from IRS instructions. Click here to download those instructions.
Step 4: Record the Payroll Transactions into Your Accounting System
You’ll also need to record your payroll transactions into your accounting system. So let me just talk about that quickly.
Recording the employee checks
You need to pay your shareholder-employee (this is you of course) $8435 in wages during the quarter. And you can do this in any way you want. You can write a check on the first or the last day of quarter for $8,485. Or you can write several checks over the course of the quarter that total $8,485.
All of these checks should be categorized as wages expense.
As noted earlier, if you make additional disbursements to the shareholder (and hopefully you will be doing this), you categorize these amounts not as wages but as shareholder distributions.
Recording the $2,280 check to the IRS
Recording the $2,280 check to the IRS works a little differently. This check actually represents two expense categories. A $765 chunk of the check represents the employer Social Security and Medicare taxes triggered by the $10,000 in total payroll. The $1,515 remainder represents the employee’s taxes that the law says the employer needs to withhold and then remit on the employee’s behalf.
This $765-$1,515 breakdown means is that you need to split the $2,280 check which gets included with the 941 form into two categories: $765 categorized as payroll taxes, and $1,515 categorized as wages expense.
Note: After you’ve categorized the $8,485 check to the employee as wages expense and also $1,515 of the check that goes with the 941 return as wages expense, your total wages expense for the quarter equals $10,000 ($8,485 + $1,515 = $10,000).
Step 5: Preparing State Payroll Tax Returns
Some states (like Washington State where I live) don’t require additional state quarterly payroll returns for shareholder-employees in one-person corporations. And if you operate in a state like this, you may only need to prepare and file the federal 941 tax returns over the course of a year.
Tip: If you are in Washington state, though, see this post so you don’t get caught in a dumb trap set by our state legislative.
But many other states you to prepare quarterly state payroll tax returns. As a generalization, these state quarterly payroll tax returns (if required) are pretty simple to deal with.
Some of the quarterly state returns amount to simple worksheets that, for example, levy a 3% tax on wages for state unemployment insurance premiums. Or simple worksheets that, as another example, charge a $.10 per hour tax on worker hours for workers compensation insurance. Other quarterly state payroll tax returns resemble the federal 941 return.
But you shouldn’t need to worry too much about all of this. Probably, your state employment agency will send you automatically information on these state returns. In this case, you need to make a couple of phone calls so you get any quarterly forms you need.
Step 6: Dealing with Any Tax Shortfalls
If paying $3,000 in income taxes won’t be enough using the method described above is not enough, you should augment the federal income taxes paid through your payroll by making quarterly estimated tax payments using the 1040ES form. For example, suppose that you know you’ll really owe $6,000 in income taxes. If through payroll withholding you’ll only pay $3,000, you’ll want to pay another $3,000 annually, or $750 a quarter, in quarterly estimated tax payments.
You can determine precisely how much federal income tax you should pay over the year by downloading the 1040-ES estimated tax payments form from the www.irs.gov website and completing the tax liability worksheet included with that form.
Note: To make regular state estimated tax payments, use your state’s equivalent to the federal 1040-ES form. For example, if you’re in California and need to pay, say, $500 a quarter in California state income taxes, you can use California’s 540-ES quarterly tax payment form.
Step 7: Preparing the Year-end Payroll Tax Returns
Even after you prepare the employee paychecks, file the quarterly payroll tax returns, and make the payroll tax deposits, you still have a small handful of additional, year-end payroll returns that need to be completed.
For example, at the end of the year, you’ll need to prepare and file a 940 Federal Unemployment Tax return. That return will assess a $434 tax if you’re a one-employee corporation in a state that doesn’t levy state unemployment tax on shareholder-employees. And that return will probably assess a $56 tax if you’re a one-employee corporation in a state that does level state unemployment tax on shareholder-employees.
Furthermore, you will need to prepare a year-end W-2 and W-3 for your employee and submit to the Social Security Administration and, possibly, to a state agency.
And it’s possible that you may have one or two additional, state related year-end tax returns to file as well.
Here’s my suggestion as to how you handle these year-end payroll tax returns: Have the person who prepares your corporation tax return prepare these year-end payroll tax returns. In other words, have the CPA who’s already doing the 1120S or 1120 corporate return do your 940 FUTA return, your W-2 and W-3 and any other state returns. He or she can easily and economically prepare these returns with the corporation return. To outsource the year-end payroll returns, get in to see your accountant early in January. Most payroll returns need to be filed by the end of January.
Some Final Comments
You have a bit of flexibility in applying the quick-and-dirty method described here. For example, if $40,000 a year in salary is too high, you can simply halve the wage and tax numbers given in the preceding paragraphs. This would of course mean you pay $20,000 in payroll over the year.
Furthermore, if you don’t or can’t do a full year of payroll, you could do, say, three quarters of $10,000-a-quarter payroll over the year. (This might make sense if your total payroll for the year should be $30,000.)
If you need to pay a reasonable annual salary of more than $40,000, you can use the basic approach described here but pay not $10,000 a quarter but rather $16,000 a quarter. (The numbers you use to do $16,000 a quarter of payroll differ as discussed in our “Five Minute Payroll” e-book which is described below.) And a $16,0000 quarterly payroll gets your shareholder-employee compensation to $64,000 a year–which should work for many S corporations.
Here’s why all this works: The quick-and-dirty payroll method described here works because of an intentional loophole in the payroll tax laws. The loophole, in a nutshell, says you can make your payroll tax deposit with your 941 tax return as long as the amount you owe is less than $2,500. If you need, therefore, to pay yourself $20,000-a-quarter, you’ll owe more than $2,500 by the end of the quarter. This breaks the loophole-related rule that opens the door to the quick-and-dirty method.
Five Minute Payroll System: Get More Details in our $10 ebook
The Quick and Dirty Payroll Method described on this page provides a fast and easy way to handle payroll in simple situations where your annual shareholder-employee compensation is less than or equal to $40,000.
However, people have regularly asked us to explain how to use the system with a larger salary amount and also to provide a cleaner, fuller monograph with forms that the small business corporation can simply add their name, address and EIN to. So that’s what we’ve finally done with our $10 ebook, Five Minute Payroll.
The Five Minute Payroll ebook explains how to do simple cookie-cutter payroll for most one-employee S Corporations using base salary amounts of $10,000 a quarter or $16,000 a quarter. (These amounts, especially if combined with a pension or health benefits, will work for almost everyone.) The e-book includes sample IRS forms you can copy to get your quarter end or year end payroll done in a few minutes, including 941s, W-2/W-3 and 940. Furthermore, the e-book provides some common-sensed tips you can use to set a reasonable salary for your S corporation and to minimize your state payroll taxes burden, too.
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As with all of our monographs and ebooks, our products come with a money back guarantee. If you don’t think what we deliver for $10 is worth it, just let us know and we’ll refund your purchase price. We make this promise to you confident that paying $10 once to save hundreds of dollar a year (or more!) on an outside payroll service will be a great investment.Note, too, that the biggest saving to you probably won’t be the money but the time.