S Corp Never Ran Payroll: Catch Up Owner Salary by Year-End

I never ran S corp payroll for myself this year: do I have to pay wages?

Yes, when the owner works in the business and takes money or property from it. Any officer of a corporation is an employee for Social Security and Medicare tax and for income tax withholding (26 U.S.C. 3121(d); 26 U.S.C. 3401(c)). The IRS says payments to an officer who does more than minor services are wages, not distributions (IRS: officer wage fact sheet). Being a shareholder does not change that. The exception is an officer who performs no services or only minor services and neither receives nor is entitled to pay (IRS: paying yourself).

Starting payroll now stops the gap from growing, but four things can make the case more than routine:

• Months already passed. The IRS says an S corporation must pay reasonable compensation before it makes non-wage distributions (IRS: compensation issues). IRS guidance does not say a late payroll cures the months before it.
• Distributions already taken. Distributions to an officer must be treated as wages to the extent they are reasonable pay for services (IRS: Form 1120-S instructions).
• More than one year, or a notice. Each year with no payroll is its own problem, and so is any IRS or state letter.
• Cash. A payroll needs cash for net pay and for the tax deposits.

Gather first:

• Bank statements showing every transfer to the owner, with dates
• The list of amounts the books call distributions
• The EIN letter and the S election acceptance letter, which shows the effective date
• Prior Forms 1120-S and K-1s, and any payroll return ever filed
• Any IRS or state notice
• Health insurance premiums the corporation paid or reimbursed for the owner
• A note of the owner's duties and weekly hours

The first step is the hard one: the salary figure and what the earlier transfers were each change what you owe and which penalties apply. If it is near year-end and nothing is set up yet (no payroll, Form 941 or state account), see "Different for you?" at the end of this page.

The order of a year-end catch-up. Only the pay date has to fall by December 31; the first deposit usually comes later.

Then fix the books and tie them to those returns.

Can I pay seven months of reasonable salary in a lump sum?

A single pay run is possible, and Publication 15 taxes back pay as ordinary wages in the year paid (IRS: Publication 15). A payment made by December 31 belongs on this year's Form W-2. Pay made after December 31 is next year's wages, and an S corporation generally cannot deduct pay owed to a shareholder until it is paid, even if the books accrue it (26 U.S.C. 267(a)(2) and (e)(1)). If December 31 has passed, the missing months of this year fall under "What if more than one year went by with no payroll?" below. Deposit due dates run from the pay date, not from the months the pay covers.

One payment is a start, not the whole fix. The run still has to:

• Withhold. Employee Social Security at 6.2% on wages up to $184,500, Medicare at 1.45% (plus an employee-only 0.9% on wages above $200,000), and federal income tax based on the owner's Form W-4. The corporation owes a matching employer share of Social Security and Medicare.
• Set the income tax withholding method before the run. A lump sum for past months may be back pay, which Publication 15 treats as supplemental wages. Its optional flat rate generally needs income tax withheld from regular wages in the current or prior year, which a first payroll may lack. Without a regular payroll period, Publication 15 withholds as if the payment covered a daily or miscellaneous period, counting the days it covers. Ask whoever runs the payroll which rule applies (IRS: Publication 15).
• Deposit and report on the schedules below.
• Be reasonable for the whole year. Pay is measured against the work done. If the owner worked all year, the figure is set against that work, and IRS guidance does not say a late start lowers it.

Plan the cash before the run. If distributions emptied the account, how money goes back in is its own question: a capital contribution and a loan are treated differently, and a loan needs real terms (see the next section). Get it reviewed before the run.

Can I call the distributions I already took wages?

Not by relabeling them yourself. The IRS can reclassify payments to a shareholder from distributions to wages (IRS: compensation issues). Its officer page describes a court test of whether the payments were truly pay for services, with the corporation's intent to limit wages not controlling (IRS: corporate officers). IRS guidance describes no step by which an owner turns past transfers into wages alone.

Two outcomes are possible, and the facts decide which applies:

The IRS also warns against treating officer pay as loans or as personal expenses the corporation paid (IRS: officer wage fact sheet). A real loan has a contract, a stated interest rate, a repayment term and a consequence for not repaying (IRS: paying yourself). To sort the transfers, see S corporation catch-up books and recording S corporation distributions.

How much salary is reasonable compensation, and what if it is too low?

The IRS gives no formula. The Code and regulations have no specific guidelines, and courts decide from the facts (IRS: officer wage fact sheet). The IRS lists factors that include training and experience, duties, time and effort, pay at comparable businesses, and dividend history. Reasonable pay never exceeds what the shareholder receives directly or indirectly (IRS: compensation issues).

A figure set too low gives the IRS room to reclassify distributions as wages, which carries employment tax on both shares plus the penalties below. For how to size the number, see S corporation owner salary; for licensed professions, see reasonable salary by profession.

How do I set up payroll accounts and deposits before the first run?

Have the owner's Social Security number and Form W-4 before the pay date. The deposit account must work by the first deposit due date, so enroll now.

For the full list, see setting up payroll.

Deposit schedule. A corporation that reported $50,000 or less of tax in the lookback period deposits monthly. The lookback period is the four quarters from July 1 two years back through June 30 of last year, and a corporation with no payroll then reported nothing. A monthly depositor deposits by the 15th day of the following month, so wages paid in December are due January 15. Tax of $100,000 or more accumulated on any day is due the next business day, and a monthly depositor that reaches it becomes a semiweekly depositor for at least the rest of that year and the next (IRS: Publication 15).

An employer whose tax for the current or prior quarter is under $2,500, and that had no $100,000 next-day deposit obligation in the current quarter, may pay with a timely Form 941 instead of depositing, but that test can fail if earlier transfers are later treated as wages, and the IRS says to deposit when unsure (IRS: Publication 15).

Which quarterly return do I file if wages start late in the year?

File Form 941 for the quarter in which wages are first paid, so a December pay date means the fourth-quarter return. Every quarter after that needs a return, even with no wages, unless the IRS has told the corporation to file Form 944, it is a seasonal employer, or it files a final return (IRS: Form 941 instructions).

Form 941 is due the last day of the month after the quarter ends: April 30, July 31, October 31 or January 31. An employer that made timely deposits in full payment of the quarter's taxes may file by the 10th day of the second month after the quarter ends instead, which is February 10 for the fourth quarter. A due date on a weekend or legal holiday moves to the next business day. A monthly depositor reports the tax by month on line 16, in the month the wages were paid (IRS: Form 941 instructions).

Check the IRS account before filing. The Form SS-4 instructions say an employer that does not choose Form 944 must file Form 941 for every quarter (IRS: Form SS-4 instructions). A corporation that reported employees on its EIN application may therefore show earlier quarters as unfiled. Reconcile that first; see behind on payroll taxes.

What penalties apply to late deposits and late returns?

Late-deposit and late-return penalties apply only to deposits and returns that miss their due dates. A catch-up run is judged by its own dates; wages the IRS treats as paid earlier are judged by those earlier dates.

The deposit rates do not add together; the highest one reached applies. When the late-filing and late-payment penalties both apply in a month, the late-filing penalty is reduced by the late-payment penalty. Deposit penalties count calendar days from the due date. The same Form W-2 amounts apply separately to the employee's copy if it is furnished late (IRS: failure to deposit penalty; IRS: Publication 15; IRS: Forms W-2 and W-3). Interest is charged on taxes paid late and returns filed late (IRS: Form 941 instructions).

A person responsible for the payroll who willfully fails to withhold or pay over tax may also face a trust fund recovery penalty under 26 U.S.C. 6672, 100% of the unpaid tax that had to be withheld (IRS: Publication 15). The IRS says an employer that treats an employee, including a corporate officer, as a nonemployee is liable for the Social Security, Medicare and income tax it did not withhold, and may also be liable for that penalty (IRS: paying yourself). The penalty is not assessed on tax figured at section 3509 rates (IRS: IRM 4.23.8). See trust fund recovery penalty; notices and relief are in behind on payroll taxes.

What forms report the payroll after year-end?

After the run, the owner gets a Form W-2, and the corporation files Form 941, Forms W-2 and W-3, Form 940 when wages reach the test below, and any state returns.

Health insurance premiums the corporation paid for an owner of more than 2% of the stock or voting power are wages in box 1 of that owner's Form W-2. Paid under a plan for all or a class of employees, they stay out of boxes 3 and 5 (IRS: compensation issues). See health insurance for owners.

Federal unemployment tax is 6.0% on the first $7,000 of each employee's wages, or 0.6% with the full state credit. Some states leave corporate officers out of state unemployment tax, and then the federal rate can be higher (IRS: Publication 15; IRS: Form 940 instructions). When a Form 940 deposit is due is in running payroll yourself.

How do I fix the books: wages, payroll liabilities, distributions?

The books need to show the wages, the taxes owed to the IRS and the state, and a distributions account that holds only true distributions.

Tie the books to the filings each quarter: the liability accounts to Form 941, and the year's wages to Forms W-2 and W-3. Forms 941 should show about twice the Social Security and Medicare tax on Form W-3, because Form W-3 reports only the employee share (IRS: Publication 15). How long to keep payroll records is in payroll records retention, and the entries are in payroll journal entries.

What if more than one year went by with no payroll?

A payroll run now reports this year's wages; it does not fix an earlier year. Wages paid now are taxed in the year paid (IRS: Publication 15).

If the corporation did not withhold because it treated the owner as not an employee, section 3509 can reduce the employee share of the tax not withheld. It does not apply to intentional disregard, or where income tax was withheld but Social Security and Medicare were not, and the full employer share is still due (26 U.S.C. 3509; IRS: Form 941-X instructions). IRS examination guidance, which does not bind in any one case, applies it to an officer paid only by distributions with no Form W-2: lower rates for distributions reported on Schedule K-1, higher rates for loans and personal expenses. An officer already paid some W-2 wages generally faces full rates on pay reclassified later (IRS: IRM 4.23.8.5.2.1). For how that prices past years, see S corporation owner salary.

How far back the IRS can go depends on what was filed. For a quarter with no Form 941 filed, it can assess the tax at any time (26 U.S.C. 6501(c)(3)). For a filed Form 941, the usual limit is three years, counted from April 15 of the next year if the return was filed earlier (26 U.S.C. 6501(a) and (b)(2)). What each year costs depends on the amounts, the dates and what was filed. See S corporation owner salary for past-year exposure and S corporation catch-up books for rebuilding the records.

Example

Illustrative US dollars, not a salary benchmark.

Consultant S corporation: wages added in the fourth quarter

A consultant's S corporation made $120,000 of profit before any owner wages, and the owner took $100,000 as distributions. No payroll ran. The owner settles on $60,000 of reasonable wages for the year and pays them in one run dated December 15. Employee Social Security and Medicare tax is 7.65% of $60,000, or $4,590, and the corporation owes another $4,590. Before unemployment taxes, the corporation needs $64,590: the $60,000 of gross wages, from which the owner's taxes are withheld, plus the $4,590 employer share.

Assuming the corporation had no payroll in the lookback period, it is a monthly depositor, so the withheld tax and both shares are due January 15. It files the fourth-quarter Form 941, Form 940, and the owner's Form W-2 with Form W-3. Wages lower the corporation's profit, so the $100,000 of distributions may exceed the owner's basis in the stock; see recording S corporation distributions. Because $100,000 already left the corporation, the owner may need to put money back, and how that is treated depends on the facts.

Election effective in March, nothing paid until November

A founder's S election is effective March 1. The corporation pays nothing from March through October and starts payroll in November. The first Form 941 is for the fourth quarter, the quarter wages are first paid; the earlier months are not reported on it. Whether pay was owed for March through October depends on facts such as whether the founder did more than minor work and was entitled to pay, so the founder documents both before choosing the November figure.

$4,000 a month in transfers, then a request to call it wages

An owner moves $4,000 a month out of the corporation for eight months, $32,000 in all, labeled as draws. Assume the $32,000 is gross wages, full rates apply and the corporation collects the employee share from the owner's later pay (IRS: Publication 15). Employee Social Security and Medicare tax on $32,000 would be $2,448, with another $2,448 for the corporation, before any income tax withholding. If the corporation pays the employee share itself, that payment is more wages and more tax (IRS: Publication 15-A). If the facts show the transfers were pay for services, each one is a wage payment on its own date. A monthly depositor's deposit for a January transfer was due February 15, or the next business day, and the late-deposit tiers count from that date. The IRS treats payments for services as wages, so the amounts and years are reviewed before anything is reported.

Different for you?

• It is near year-end, you have taken only distributions, and there is no payroll, Form 941 or state account yet: the salary figure, the date and form of the catch-up run, how past transfers are treated and whether earlier years are exposed all change what the IRS may assess, so decide them together before the run; see corporate tax help.
• More than one year has passed with no payroll, or an IRS or state notice arrived: each changes the answer; see past-year exposure and behind on payroll taxes, or corporate tax help if numbers or notices are involved.
• Several years of books are behind: rebuild them first; see S corporation catch-up books or bookkeeping help.
• The owner has only an ITIN, or lives outside the US: payroll, work authorization and the owner's own filings can change the answer; see corporate tax help. For a Canadian resident owner, see US S corporation owner in Canada.
• More than one owner or family member worked and was paid by transfer: each person's pay is its own question; see paying family on payroll in an S corporation.
• You paid your own tax through EFTPS without withholding, or received a CP05A notice: see S corporation owner tax paid through EFTPS.
• The S election was filed but the business was reported on Schedule C: see S corporation reported on Schedule C.
• You need a salary benchmark for a licensed profession: see reasonable salary by profession.
• You will run each quarter yourself afterward: see running payroll yourself.