Setting up payroll is a key step toward operating as an S Corp and managing the related tax consideration
Overview: Why Payroll is Critical to the S Corp Savings Strategy
The primary reason you’ve formed an S Corp is to unlock significant tax savings. To do this, the IRS requires you to play two distinct roles: Business Owner and Employee.
- The Two Roles: As an Owner, you are entitled to the company's profits. As an Employee, you provide the services that make the company run. Because the IRS views you as an employee of your own corporation, you are legally required to pay yourself a salary through a formal payroll system—just like any other staff member. To be more specific, If you perform substantial services for your S Corp, the IRS expects you to be paid reasonable compensation as wages through payroll before taking shareholder distributions (which are generally more tax-advantaged - see below for why).
- The Beauty of the Savings: Once you’ve paid yourself that salary, the "magic" happens with Shareholder Distributions. Any profit left over can be taken by you as the Owner. These distributions are generally not subject to Social Security and Medicare (FICA) taxes, which can reduce overall employment-tax exposure compared with self-employment income.'
- Reasonable Compensation: Because distributions are so tax-advantaged, you can't pay yourself entirely through them. 'Reasonable compensation is the area the IRS most often examines for S corps, so setting a thoughtful salary is important.'
- How We Help: Collective will provide you a reasonable compensation range using data-backed benchmarks informed by IRS guidance and BLS wage data to help you set a starting salary. *Note: Collective does not guarantee the salary range will meet the IRS reasonable-compensation standard — you remain solely responsible for the salary you choose.
Payroll Setup:
All users who have never run payroll previously with a different provider or with Gusto will go through the new payroll setup process. Users who have previously ran payroll with a different provider will go through the payroll migration process (detailed below). Users who have previously ran payroll through Gusto will go through a payroll takeover process (also detailed below).
Step 1: Company Configuration
We begin by setting your business up on payroll. Collective’s payroll is powered by Gusto.
- Verify Business Details: Review your pre-populated company name, EIN, and address. If anything looks off, click “let us know” to message us directly.
- Connect Your Business Bank: Link the business checking account you’ll use to fund your payroll (this is the business banking account that you will pay from, not the personal account you will pay to).
- Set Your Pay Schedule: Set your initial pay schedule. We recommend that our S Corp members generally stay on a monthly pay schedule. This makes it easy for you to manage cashflow. After paying yourself a reasonable salary, any remaining profit can generally be distributed to you as a shareholder. Our calendar preview will show you exactly when funds are debited and when they arrive in your personal account. You can always skip or change your payroll schedule at any time.
Step 2: Employee Onboarding
Now, you will onboard yourself as your company's first employee.
- Finalize Your Salary: Review the recommended reasonable compensation range we've calculated for you. You can select the specific amount that reflects your role and current business cash flow for your initial salary. You can always change your salary if your business needs change, or skip payroll and true up at the end of the year if your cashflow varies.
- Link your personal bank account: Link the personal bank account you want your salary to go into
- Add in your federal and state tax withholdings: Confirm your federal and state tax withholding preferences. Note: Collective cannot provide tax advice for your specific situation. We can provide general guidance in line with what is available on government tax forms. For specific tax advice, please consult a tax expert or CPA.
- Let us know if you plan on adding in any health insurance or 401K deductions: Let us know if you want to, or are thinking about, funding your health insurance or 401K through your payroll - our team will reach out to you to help make s sure this is set up correctly.
Step 3: Document Signing
Last step, you’ll sign required authorizations in your dual role as both employer and employee to get payroll set up for your business, and payments set up for yourself as an employee.
- Company Forms: Sign Form 8655 and state-specific forms so we can handle tax filings and payments for you.
- Employee Forms: Complete your personal W-4 and direct deposit authorization.
When you complete these forms, you’re done with payroll setup!
What’s next: Collective Will Review Your Information
Once you’re done with your payroll setup, our team will review all your information for accuracy and completeness within two business days. If we see any issues, we will reach out to you via email for clarification. We will then submit your information to our payroll partner, Gusto, to complete payroll setup. There will be no further action on your end unless we run into any issues. You do not need a separate Gusto account.
If you also indicated that you want healthcare or 401K contributions deducted from your payl, a member of our team will be reaching out to you via email within 2 business days to help make sure they are recorded correctly in our accounting and payroll systems.
You will receive emails from our payroll partner, letting you know when your payroll setup is complete and you are ready to run your first payroll. This usually happens within 2 business days. Occasionally, Gusto may need more information or forms signed to setup your payroll and you will get emails directly from them to fulfill these requests. You do not need a separate Gusto account to do this or to run payroll - you can do everything you need through Collective once payroll is set up.
Team Expansion (Optional)
If you have additional W-2 employees or 1099 contractors, you can set them up later in your Payroll dashboard after your initial payroll setup is complete.
Running Your First Payroll
When you receive a confirmation email from Gusto that your payroll has been set up, you will be able to run your first payroll.
Running your first payroll early in the year creates a record of reasonable compensation for the tax year. (Your S corp election is established separately, by your Form 2553 filing.
Once you run your first non-$0 dollar payroll, this will kick off a separate process on Collective’s side to register your business as an employer in the state that you work in. This is a legal requirement. This will not block you from running your first payroll and will make sure that you stay compliant with legal state requirements for reporting.
This process kicks off automatically and you do not have to take any additional actions. If we run into issues or questions, our team will reach out to you.
Common FAQs
How often should I pay myself through payroll? We recommend most members choose a monthly schedule. It’s consistent for your personal budget and keeps your bookkeeping clean. A monthly cadence also makes it easy for you to remember to file any reimbursements and transfer any shareholder distributions on a regular basis.
What if my business revenue fluctuates? If your business profit is steady but your cashflow fluctuates, your salary payments and distributions are flexible. If you have a high-revenue month, you can pay yourself your normal payroll and take a larger distribution. If things are lean, you can skip your payroll cycle and distribution. Collective will calculate how much you have paid yourself through salary and shareholder distributions throughout the year and you can do a lump sum catch up at the end of the calendar year through an offcycle payroll.
What if my business profits change meaningfully? Yes. If your business revenue changes, you can re-run our reasonable compensation calculator with updated inputs and change your salary to keep you compliant and tax-efficient. We usually recommend reviewing this at least twice a year or if your business revenue changes by more than 15%.
How do I pay myself through reimbursements? Use the Reimbursements tab in accounting to put in your reimbursements on a monthly basis. Once you calculate your total reimbursements, transfer this amount from your business bank account to your personal bank account. Properly substantiated business reimbursements paid to you under an accountable plan are generally not taxable.'
How do I pay myself shareholder distributions? Once you pay yourself your salary via payroll, see how much profit you have left over and how much of that remaining profit you want to distribute to yourself as a shareholder distribution. Once you decide on this amount
Do I have to pay taxes on distributions? In general, you pay income tax on business profits whether you take them as wages or as distributions,, but distributions are generally not subject to Social Security and Medicare (FICA) taxes (up to 15.3% in tax savings).
Can I change my salary later? Yes. If your business revenue changes, you can re-run our reasonable compensation calculator with updated inputs and change your salary to keep you compliant and tax-efficient. We usually recommend reviewing this at least twice a year or if your business revenue changes by more than 15%.
Payroll Migration:
Users who have previously run payroll with a different payroll provider than Gusto will go through the payroll migration process in addition to the payroll setup process. In this process, we will get key information from users so that Gusto can go and get their old payroll information migrated into their new Collective (powered by Gusto) payroll system.
The process: Enter a few key pieces of information about your previous payroll provider and your payroll setup. Collective will review this information and begin the migration process to Gusto. The entire process should take around 2 weeks - meaning it will be around 2 weeks before you can run your first payroll with Collective. If we have any questions or issues, we will reach out to you via email.
Information need from you:
- Your previous payroll provider: Select from the dropdown list of payroll providers. Choose the “Other” option if it’s not on the list.
- Your first pay date: Choose when you would like your next pay date to be. This date must be at least two weeks into the future to account for migration time.
- Number of terminated employees: Enter the number of full time and/or part-time employees you terminated in the past calendar year.
- Number of employees: Enter the number of full time and/or part-time employees you currently have, including yourself if applicable. Do not include any contractors.
- What is your standard pay schedule: E.g monthly, bi-weekly, weekly…
- Do you have employees that work remotely?: Answer Yes or No here
What’s next after you submit your information?
- You’ll continue through the rest of payroll setup with Collective Payroll (powered by Gusto)
- Collective will review the information and begin the migration process to Collective Payroll (powered by Gusto). The entire process should take around 2 weeks. This means it will be around 2 weeks before you can run your first payroll with Collective. If we have any questions or issues, we will reach out to you via email.