Small Business S Corp
So, if you are one of a growing number of small business owners who have decided to make an organizational change to become an S corporation here is a little advice. Lets assume that in previous years you ran a small business as a sole proprietor. That means you filed Schedule C along with your 1040 where you report all your business activities. And I am sure that you realized when you filed your 1040 that there was a nasty old additional tax called the self employment tax that increased your tax liability. This tax is actually the self-employed equivalent of the social security and medicare tax that employees must pay. But as a business owner your revenue is from sales or services and not payroll. So you must pay your social security tax in this manner at the end of the year.
Now you are ending the first year in which you made your change to an S corp. Nothing else has changed, you still perform all the work like you did with the sole proprietorship. And of course all the revenues and expenses that you used to report on schedule C is now being reported on Form 1120S. The net income (or loss) from that schedule will flow to your form 1040 by means of a conduit schedule called the K-1. The amount from the K-1 will really be the amount that you used to report as business income on line 12 of your 1040, but you can't do that now because you are an S corp and you must report all earnings from this investment (yes, it's considered an investment) on line 17 of form 1040. Additionally, you are not required to file form SE to report the aformentioned self-employment tax. Well, you can't get away with not paying this tax so how do you do that?
It may surprise you to learn that after all the years of being a business owner, you are now for tax reporting purposes no longer considered a business owner. Because you perform all the work in operating your S corporation what you really are is an employee of a company that you are a 100% shareholder in. Wow, bet you never thought that, you still consider yourself self employed. Not really, not anymore at least for tax purposes.
So, here is my advice. You need to set up payroll for yourself. Pay yourself a reasonable salary and have tax withholdings just like any other worker. This way you will satisfy the social security and medicare tax requirements. You will also have to pay the employer's share and unemployment insurance premiums so your business is going to take a little hit. But you will be fufilling IRS requirements and you still have the benefits of your S corp.