How to Determine a Fair and Reasonable Salary for an S Corp Owner

Hi there. This week's post was gonna be some other topic, and then I've got this question from somebody that used to be in our Law Lab, and I thought that this would be a great question to make a post about because it's something that happens in a real-life scenario. And as a legal bookkeeper, you're gonna find this is something— even a regular bookkeeper, this is something that happens. And I wanted to bring it to your attention because literally we're at the end of the year and we're gonna find that we're at a point where we— to fix it after we go into January is a lot worse. So the person wrote to me and said, this is super urgent because it's just before the end of the year. I need to figure out how to pay an owner of an S corp a salary. We've been taking out shareholder distributions, but he was never paid a salary for the entire year. The accountant of the firm told us yesterday that I should run a payroll out of the account without cutting a check. I called QuickBooks and they told me that that's not possible to do. So can you please get back to me? The accountant's on vacation and I need your help. So that's what I'm here for, to help. And that's a great question because this is real life scenario. It happens. Sometimes it happens when you get a brand new client in the new year and the new client is, was an LLC, took distributions, and then at the end of the year changed to an S corp and then never took a salary. So how do we book this in? So the person has already received the money. So it was just gonna say that the client, the tax person said he needs to draw a salary of $100,000, but the client's already taken the $100,000. So we're going to need to show the salary by going into QuickBooks payroll, going into where it says bonus payroll, and you're gonna run a bonus check. The key is if they get paid, most people get paid by direct deposit. So you're gonna make sure that when you run this, you uncheck the box for, for direct deposit. We don't wanna pay them again and suck all the money outta the business. You want to make sure this is kind of like a paper trail in this case. So you're gonna run this check, and there's 2 things when you go into bonus check. You can either do a bonus check with nets. You just run a check and like, I give $100 and the person ends up with like $65 because the rest is taxes. Or you can gross it up. So if the client is supposed to be paid $100 grand, you're gonna run a check for $100,000. And this is where you might want to talk to Intuit about how to do this, and you don't have a lot of days. You don't have a lot of options, but sometimes running a different couple of checks nets out to be more for the client. But you're trying to get this done. A big check like that's probably gonna be a big chunk of taxes. But so when you do, do this, you might want to play around with a couple scenarios. But in this case you're gonna run a check for $100,000. It's gonna be a check. And you're gonna do it grossed up. So you're gonna do it so that the check itself is $100,000. It would be $100,000 you'd have to print. Now you're gonna uncheck to be printed because you're not printing this check. You're gonna process it. Make sure you already created an officer wages account. That's gonna be a subaccount under your payroll expenses. It'll be under right near your regular wages for everybody else, because you want to separate shareholder wages, or officer wages— like to call it officer wages— from regular wages, because that needs to be separated for the tax person. And then you also have to deal with their healthcare, which is a whole other topic. And then you want to do a journal entry. So now you're going to run this check. It's going to show that the person was paid $100,000 in officer wages, because that's where you're going to When you set the person up in QuickBooks Payroll, you're gonna set it up where they get that separate account for officer wages. You can also do a debit at the end of the year and debit credit and kind of move it outta regular wages. I like to set it up the right way so that it gets booked in properly. Sometimes you just throw it all into the regular wages and then move it out. But you're gonna have it land in officer wages. It's $100,000 is gonna show as the salary for this person. Now, how do I get rid of that check? I'm not going to print it. I'm not going to give it to the client. They don't need to get another $100,000. You're going to do a journal entry. And in that journal entry, you are going to credit— I'm sorry, you're going to debit. Always backwards. You're going to debit the bank account that this check was drawn on, which will make a deposit. And you're going to credit distributions because you're taking it out of distributions. It's been booked into wages when you created the paycheck. And now all the tax checks are going to be created, all the tax withdrawals are going to be created off of that because Intuit's going to do all that math for you and put it all together. You're going to date the check in this year so that the check date— make sure the check date is in 2024. And then as you process this, when you go to reconcile that bank account, you're going to see the debit for that deposit you're creating with the— with the debiting of the bank account. Journal entry and the credit will be obviously the check, bonus check. Neither— they're going to offset each other, so they're not going to affect the bank account. It's going to just wash each other out. The money's already been taken out by the shareholder checks. So you've got that entry put, put in. You're now hitting the wages account in lieu of hitting the distribution, which is a total, totally different tax scenario because now you're paying taxes on it. The tax money's going to come out. For that check, and now you'll have proper accounting. So a little bit of a puzzle, puzzle twister, I guess you would say. But it's in the article attached. It's going to talk about how to determine wages for an officer by the type of business they have, benchmarking, how many hours they work. There's a lot of calculations that go into that. When in doubt, talk to your tax professional and get that number from them. But If you want to determine it yourself, let's just say you do your own taxes, you want to determine it, you're on the smaller side, you can do it that way. It's just go through and read the article. It will tell you all the steps and even put a snippet of the IRS guidelines for determining that proper salary for your S corporation. And then just do this accounting with your payroll program to pay the taxes, show the entry for the check. And have the accounting be correct. Now that person will get a W-2 that's going to say $100,000 in wages and then the taxes that were produced off of that transaction. So I hope this is helpful. If you have any more questions, feel free to reach out. We have these kind of things come up all the time in the Accountants Law Lab, so join us. Thank you. Bye-bye. Bye.