December 15, 2020
Quarterly Wages vs. Monthly Wages
We have established that, as an S-Corp, you must pay yourself reasonable compensation.
This is one of the rules you agreed to follow when taking the S-Corporation election. The IRS deems that reasonable compensation is a fair wage that you would pay to anyone else doing the same work for the company. As an S-Corp, you pay self-employment taxes on this salary, not on the distributions or remaining profits of the company. Because of this, the IRS wants to make sure that you are not avoiding self-employment taxes by paying yourself too little. You do not want to pay yourself too much and jeopardize the day-to-day operations and cash flow of the company or pay more self-employment taxes than necessary.
You have options when paying yourself a salary. Common payroll frequencies include weekly, biweekly, semi-monthly, monthly, or quarterly. Many states have requirements for how often you must pay your employees, including yourself. Here is a list of the filing frequency requirements for each state.
Be sure to note if the state regulations apply to shareholder-employees, as some states will require a certain frequency for regular employees with no restrictions on how often a shareholder-employee must be paid. This means you may be able to pay yourself on a quarterly basis, even if you must pay any other employees on a semi-monthly or monthly basis.
Here at Formations, we recommend either a monthly or quarterly payroll cycle for the shareholder-employee. There are advantages and disadvantages to both options. Give us a call today and we can sit down and review the frequency that will work best for you and your business. Also, as part of the services we provide, we will perform a reasonable compensation study. This study will provide us with statistical data to support and defend your salary for your industry using the many hats approach allowed by the IRS.
Paying Yourself on a Monthly Basis:
Cash flow is one of the biggest advantages of running a monthly payroll. When you pay yourself monthly you can easily budget the expense for your salary and payroll tax obligations. Other employees will appreciate a monthly payroll cycle as opposed to a quarterly one, as it makes personal budgeting easier. Monthly payroll means payroll is run twelve times a year, which means you will pay less in processing fees than if you were running a biweekly or semi-monthly payroll. You can streamline your payroll to coincide with any benefit payments, such as health insurance and retirement contributions. And any reimbursements for out-of-pocket expenses based on your Business Accountable Plan can be tracked and processed through your payroll.
A monthly payroll allows for increased flexibility. Your salary is based upon the actual services you provide the company. The services you perform should be commensurate with the income generated. You can reduce your payroll in a month with decreased revenue to reflect this.
A disadvantage to the monthly payroll cycle is that you are obligated to pay yourself even when you have no income. The IRS requires the remittance of payroll taxes based upon prior year payroll tax obligations and liability amounts, known as the look back period. You may have to remit the payroll taxes, which include federal withholdings, Social Security, and Medicare, monthly, which can impact cash flow and business revenue. And, if you have hourly employees, getting paid once a month could be a deterrent, as it can make personal budgeting a challenge. Again, be sure to check with your state regulations, as many states require more frequent payroll cycles for non-shareholder employees than a monthly one.
Paying Yourself on a Quarterly Basis:
Electing to pay yourself on a quarterly basis means you run payroll four times a year, which saves you time and money in processing fees. A quarterly payroll is good for a business with income fluctuations, like real estate agents and consultants working on projects. It allows you to keep funds in the business for day-to-day operations while providing yourself with a regular paycheck. And, if you run payroll quarterly it means that you will only have to remit the payroll taxes and required reports on a quarterly basis. Many payroll taxes, such as federal unemployment (FUTA) and most state payroll taxes, are due on a quarterly basis, so running payroll once a quarter allows you to pay these obligations as they are incurred. Another advantage is that, in reviewing the overall profits for the quarter, we can help ensure you are in line with paying your federal tax liabilities through payroll withholdings, rather than making additional quarterly estimated payments.
A disadvantage to the quarterly payroll cycle is that it can lead to low cash flow. In addition to the payment of your salary, you must also pay quarterly payroll taxes. If you have additional employees, a quarterly payroll cycle may be a deterrent to them, as it can create personal budgeting and planning issues for an individual that receives a paycheck every three months. Many states require more frequent payroll cycles for non-shareholder employees, so this may force you to maintain different payroll frequencies for yourself and any other employees. Another potential issue with running payroll on a quarterly basis, especially if you have employees other than yourself, is ensuring that you are accurately tracking hours and maintaining records to correctly calculate wages, deductions, and taxes. Proper record-keeping is especially important if you have a Business Accountability Plan that allows for the reimbursement of out-of-pocket expenses through your payroll.