Navigating Payroll Pitfalls in Your S Corp: Solutions and Strategies

Feb 28, 2024 | Blog | 0 comments

As we close another year, many small business owners might find themselves in a bind with payroll, especially if operating under an S Corporation structure. Whether you’re reading this in the twilight of 2023, lamenting over a missed payroll opportunity, or you’re already in 2024 wondering about your next steps, there’s crucial information you need to navigate this complex situation.

The Retroactive S Corp Election: A Saving Grace

First, let’s address a common concern: the possibility of making the S Corp election retroactive to January 1, 2023. This is more than just feasible; it’s a strategy often employed to harness the benefits of S Corp status, including the critical requirement to pay a salary to materially participating shareholders. If you find yourself post-Thanksgiving, perhaps a bit downtrodden from another Cowboys defeat, it’s time to accelerate payroll setup to ensure at least one payroll event is processed by year-end.

However, if the calendar has already flipped to 2024 and 2023 payroll opportunities have slipped by, fear not. There are strategies to consider, ranked here from the most to the least elegant solutions.

Option 1: Issue a 1099 to Yourself

Surprisingly, one viable option involves issuing a 1099-NEC to yourself for a portion of the business’s net income. This amount gets reported on Schedule C of your individual tax return, thus subjecting it to self-employment taxes. While not as straightforward as traditional W-2 compensation, this method still aligns with the IRS’s expectations for officer compensation, meeting the reasonable salary requirement in a less conventional manner.

This approach, albeit not the first choice for many, serves as a plausible first-year workaround, ensuring employment taxes are paid. However, it’s crucial to note that this is a temporary fix, with the expectation that proper payroll setup and W-2 filings will resume in the following year.

Option 2: Manual Late Payroll Event

Historically, some businesses, including ours, have processed late payrolls manually. However, with the transition to using services like ADP for payroll processing, the flexibility for late payroll events has significantly diminished. While technically possible, late payroll processing is fraught with potential complications, including a barrage of IRS and state notices. It’s a path we advise against.

Option 3: Roll the Dice

While we, as tax professionals, cannot endorse this option, it’s worth mentioning that some choose to treat their first year as a learning curve, foregoing W-2 or 1099 filings altogether. Given the relatively low audit rates for S Corps, this gamble might seem tempting. However, it’s a risky strategy that could lead to IRS-imposed wage imputations, additional liabilities, and a tangled mess of state and federal notices. It’s a strategy that not only jeopardizes compliance but also our willingness to engage as your tax advisor.

Emphasizing LLC Protection

Regardless of the payroll path you choose, it’s paramount to have an LLC in place. This provides a layer of protection, ensuring that the effective date of your S Corp election aligns with your business’s operational timeline. This isn’t just our recommendation but a commonly endorsed best practice among tax professionals and legal advisors.

Missed payroll in an S Corp doesn’t spell disaster, but it does require immediate attention and strategic planning. Whether you opt for a temporary 1099 solution, navigate the complexities of a late payroll event, or choose to set up your payroll correctly for the future, it’s crucial to proceed with knowledge and caution. And remember, we’re here to help you through these complexities, ensuring compliance and peace of mind.

Navigating payroll pitfalls, especially in the intricate world of S Corps, demands expertise and timely action. As we move forward, let’s prioritize compliance, strategic planning, and the peace of mind that comes from knowing your business is on solid ground.

Reach out if you need help!