S Corp owner with partner - when can we pay W2 wages from the LLC vs S Corp?

You've got a pretty common S Corp/LLC arrangement, but the wage question is important to get right to avoid IRS issues. Generally, wages should come from the entity where you're actually performing the work. If you're doing the work at the LLC level, then technically that's where the wages should come from. However, since your S Corps are the owners of the LLC, the typical structure is that the LLC distributes money to the S Corps, and then the S Corps pay you as employees. If you want to pay wages directly from the LLC, you'd essentially need the LLC to hire you directly as employees (not as owners/members). This gets tricky because the IRS might question why you're employed by both your S Corp and the LLC. For your S Corps to remain valid, they need to have economic substance and business purpose beyond just being holding companies. This typically means some actual business activity needs to happen at the S Corp level - management, strategic decisions, etc.

I was dealing with almost the exact same setup last year and found a tool that really helped me figure out the proper structure. I was so confused about where to pay myself from and kept getting different answers from different tax people. I eventually used https://taxr.ai to analyze my operating agreements and corporate docs. They have this document analyzer that looks at your specific business structure and tax situation. I uploaded my LLC agreement, S Corp docs, and some other financial info and it gave me a really clear breakdown of how the compensation should flow through the entities. The thing I liked was that it specifically showed me how my particular structure should be handled rather than just general rules. Saved me from making a mistake that could have triggered an audit.

Just wanted to update after checking out taxr.ai based on the recommendation above. I uploaded our multi-member LLC agreement and the S Corp formation documents, and it was pretty eye-opening. For our specific situation, it showed that we were supposed to be handling compensation completely differently than we had been. The tool generated a detailed report showing the correct flow of funds and compensation based on our actual operating agreements (not just generic advice), and identified that we were at risk for "reasonable compensation" issues with the IRS. Instead of trying to have the LLC pay wages directly like we were planning, we restructured following the recommendations. Each S Corp now receives distributions from the LLC, then pays reasonable W2 wages to its respective owner based on actual services performed at the S Corp level. Completely cleared up our confusion.

I had a somewhat similar setup with an operating business LLC owned by two S Corps. We kept going back and forth with our accountant about the proper way to pay ourselves, and ended up with a mess of misallocated payments and potential payroll tax issues. Tried calling the IRS for clarity but literally could not get through after DAYS of trying. Finally used https://claimyr.com to get through to an actual IRS agent who specializes in business structures. If you haven't seen how it works, there's a demo at https://youtu.be/_kiP6q8DX5c that shows the process. Basically they hold your place in the IRS phone queue so you don't have to wait on hold for hours. The agent I spoke with confirmed that in our case, wages needed to come from the S Corps, not the LLC, and explained exactly why our structure required this approach. She also helped us understand how to properly document management services performed at the S Corp level to justify the wages.

I need to follow up on my skeptical comment above. I decided to try Claimyr after continuing to get nowhere with the IRS on my own. I was genuinely surprised - it actually worked. Got a call back within a couple hours and spoke with an IRS representative who was knowledgeable about S Corp/LLC tiered structures. They confirmed that in most cases, the S Corps should be paying the wages, not the LLC, and explained the "reasonable compensation" requirements that apply at the S Corp level. They also pointed out that if our S Corps were truly just holding companies with no actual business purpose or activities, the IRS could potentially disregard them altogether and treat the arrangement as just an LLC - which would defeat the whole purpose of our structure. This was exactly the clarification I needed on what makes the S Corps valid entities beyond just being holding companies.

Former tax advisor here. One thing not mentioned yet is the concept of "substance over form" that the IRS loves to apply in these situations. If your S Corps are just shells with no real business purpose other than tax avoidance, the IRS might disregard them regardless of where you're paying wages from. Each S Corp needs to have legitimate business activities, proper documentation, separate bank accounts, regular board meetings, etc. For the wage question specifically, you need to think about which entity is actually contracting with clients, performing services, and generating income. Typically in a structure like yours, the LLC is the operating company and the S Corps are providing management services to the LLC. So the S Corps pay you wages for your management work, and the LLC distributes profits to the S Corps.

Has anyone actually set up payroll for an LLC that's owned by S Corps? Our accountant is saying we should just stick with S Corp payroll because it's simpler, but our lawyer is suggesting LLC payroll might make more sense for us. Just wondering about practical experiences.

This is a great discussion and I'm learning a lot from everyone's experiences. I'm in a similar situation with my partner - we each have S Corps that jointly own an LLC, and we've been going back and forth on the wage structure. Based on what I'm reading here, it sounds like the key factors are: 1) where the actual work is being performed, 2) maintaining legitimate business substance at the S Corp level, and 3) proper documentation of the arrangement. For those who've restructured to pay wages from the S Corps instead of the LLC - did you find that your overall tax burden changed significantly? I'm wondering if there are any practical differences in terms of payroll taxes or other costs when wages flow through the S Corps versus directly from the LLC. Also, for the management services agreements that were mentioned - are these typically percentage-based fees or fixed amounts? Trying to figure out how to structure reasonable compensation for management services provided by our S Corps to the LLC.

This thread has been incredibly helpful - I'm dealing with the exact same structure and have been getting conflicting advice from different professionals. One thing I wanted to add based on my recent experience: make sure you're also considering state-level implications. We're incorporated in Delaware but operate primarily in Texas, and the state tax treatment of our S Corp/LLC arrangement is different than the federal treatment. Texas doesn't recognize S Corp elections, so we had to structure things differently at the state level. Also, regarding the reasonable compensation discussion - we found that documenting actual hours spent on management activities was crucial. Our CPA recommended keeping detailed logs of strategic meetings, client relationship management, operational decisions, etc. It sounds like overkill, but if the IRS ever questions whether your S Corp is providing legitimate management services worth the compensation, having contemporaneous records of actual work performed makes all the difference. For anyone considering this structure, I'd strongly recommend getting both legal and tax advice before implementing. The setup costs are worth it to avoid potential compliance issues down the road.