S-Corp bonus to employees at the end of the year

[JVersaguis]

We just did a change this year from LLC partnership to LLC S-Corp. We have been paying ourselves payroll via QB Payroll so will be issued W-2's. I understand that the payroll is business tax deductible on the S-Corp side which is part of what causes tax savings. About half the year we weren't doing payroll since we had not been approved as an S-Corp right at the beginning of the year. I want to be prepared for taxes this year and want to know if it might be a good idea to pay ourselves a "bonus" at the end of the year to make sure our LLC S-Corp does not owe taxes either? It won't be an exorbitant amount since we are still a small business without that much capital in our account.

[dev145]

Hello JVersaguis,

S-corp. is a pass-thru entity that means S-corp. itself do not pay any federal taxes (some states might have certain type of tax at entity level) but income flows to each shareholder via k1 and shareholder pays tax on that income at individual level. 

As for "Bonus" you mentioned, I might need little more clarification. Are you talking about bonus as in extra wages that will be reported on W2 or are you talking about distribution (Cash/property distribution from S-corp.)?

If each shareholder decided to take a bonus as an employee, you will report that on W2 and S-corp., will take a deduction for it. Again S-corp. do not pay any federal taxes. 

If each shareholder decided to take a cash distribution form S-corp., there will be no deduction on income but it will be reported on each k1 box 16. Generally distributions are not taxable unless they are in excess of shareholder basis.  

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[JVersaguis]

Thank you for the reply. I am still very confused and unsure how to file taxes this year. We will be an S-Corp, which you said the S-Corp does not file taxes. But, we will still be issued K-1's for 2024? Why? I thought that was for partnerships only. Husband and wife are the only 2 shareholders and the only 2 employees. Same 2 people. The amount in the W-2 won't be the same amount in the K-1, correct? Example: Let's say 2024 the business made $100k. $50k was disbursed as W-2 earnings ($25k to husband and $25k to wife) and the other $50k was before the S-Corp so they will be K-1 shareholder disbursements? Then, for 2025 we will be an S-Corp the whole time so the full $100k would be W-2 ($50k to husband and $50k to wife) with $0 in the K-1s?

[quorumof1]

Hi There:

S Corp wages to officer shareholders should be based on the fair market value of service provided to the company. In theory company profitably should not effect officer wages. However, in reality it could be different due to cash flow. A year end bonus is a good idea if needed to achieve fair market value of service.

S Corp - will pay additional employment  taxes on year end bonuses and issue W2's and K1's, reporting income to all shareholders.

Individual - A higher W2 could lead to an higher retirement account deduction and lower net investment income tax-If applicable.  From just an income perspective, a combination W2 and K1 should not by themselves increase individual income since a higher W2 will lower S Corp pass through income.

[dev145]

 I think you are confusing S-corp. with C-corp. C-corp. do pay taxes at entity level and any cash distributed to shareholder will be reported as dividend income to shareholder. There is no k1 with C-corp.

S-corp. do not pay taxes but it still have to file a 1120-S tax return. Just like partnership, S-corp. is also a pass-thru entity that means, there will be k1 for each shareholder. 

Let's take your example. S-corp. w2 wages are 50k (25k for each shareholder) and net income after w2 deduction is 50k. S-corp. will not pay any taxes to IRS. It will only report all income and expenses and k1 for each shareholder. On your k1, box 1 will have 25k income for each shareholder (Assuming each owns 50%). You will report w2 just like how you report any other w2, you will also report 25k income from k1 and pay taxes on that income. If each of you decided to take 25k distribution form S-corp., your k1 will have that reported on box 16. You will still report w2, box 1 as income and but money taken out from S-corp. will be reported as distribution. Please note K1 will be generated regardless of distribution. 

Please reply if you still need any more clarification.

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[JVersaguis]

But, we are already getting paid as W2 employees fair market value compensation for the work performed for the company.

You're saying that in addition to that, we will need to make sure that the K-1's reflect a "reasonable" amount paid to ourselves? Example again: $100k gross - $25k wife W2 -$25k husband W2  = $50k - $25k business expenses = $12,500 K-1 to wife and $12,500 K-1 to husband. So, we would only be liable for self employment taxes on the K-1 amounts.

But, we CANNOT do $100k gross - $37,500 wife W2 - $37,500 husband W2 - $25k business expenses = $0 for both K-1's to husband and wife ?

[KristinaK]

No, that's not what we are saying. Per your example:

Gross revenue - $100K
W -2 expense - $75K
Net corporate income - $25K

If you have other business expenses to reduce the $25K to zero, then your Schedule K-1 will have zero and you will only report your W-2 income on your individual tax return. However, distributions are NOT an expense. They will not reduce your net income. 

If you do have net income, then that net income will be reported on your K-1 and you will report it on your individual tax return in addition to the W-2 income.