I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox 👇 Also on YouTube at PlugAccountingandTax!
5 Ways to #@&! Up Your S-Corp
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S-Corps are a tool 🧰 like any other tax strategy - not a one-size fits-all solution for every business. And in most cases, businesses with debt or multiple owners should actually be a partnership, 🤝 with S-Corps layered in the org. chart along the way. But if you have made it past my S-Corp gatekeeping, I wanted to share a quick-hitting list of 5 ways to still mess it all up:
Unequal Profit DistributionsThe number one rule for an S-corp is simple ☝️: profits must be split based on ownership percentages. If you own 60%, you get 60% of the profits. Period. No exceptions, even if one owner works harder or deserves more money. If you do need to make concessions to get cash out of the entity not based on ownership, this is where you have to run a W2 and pay a bonus - which is less tax efficient. If your company agreement says owners get paid different percentages than they own, the IRS stops viewing you as an S-corp. They’ll treat you as a C-Corp instead, and when that happens, everything about how your taxes are calculated changes. 🪄 Operating Agreements That Look Like PartnershipsPull out your operating agreement and read it carefully. 👀 The language you use matters a lot. Watch for specific red-flag terms like 👉 “capital accounts,” “preferred returns,” or anything that refers to partnership tax 👈 rules. If these phrases are in your agreement, the IRS may believe you’re not actually structured as an S-corp, even if you filed the right paperwork electing S-corp status. If this is the case, step 1 is to seek professional help. You may be qualified for relief under Rev. Proc 2022-19. 🦺 Not Taking a Real, Reasonable SalaryThis is the most common mistake S-corp owners make. If you own the S-corp and actively work in the business, you must pay yourself a reasonable W-2 salary and file all required payroll taxes. 💸 Many owners try to take everything as profit distributions to avoid payroll taxes. The IRS knows this trick, and they don’t like it. 🙅 You need to pay yourself what someone else would earn doing your job. If you run a plumbing company making $400,000 a year, you can’t pay yourself $30,000 and pocket the rest as distributions. It's worth noting that after qualified business income (QBI) came out in 2017, this changed incentives away from low-ball salary. But it's still a risk. Distributions Financed by Company DebtBe careful about how you fund owner distributions. If your business plan relies on taking out loans and using that money to pay distributions, 🔀 an S-corp is the wrong structure. Debt works differently in an S-corp than in a partnership. In a partnership, company debt increases your tax basis ⬆️, which lets you absorb losses and take distributions without immediately owing taxes. In an S-corp, debt doesn’t increase your basis. ↔️ If you take a distribution larger than the money you personally invested out of pocket, you owe taxes on the excess - even if that money came from a business loan. If your business model depends on using debt to finance owner payments, you should use a different structure than a S-Corp. 🛖 Shareholder Loans Without Proper DocumentationIf you lend money to your S-corp or the company lends money to you, it must be properly documented. That means a promissory note with clear loan terms, an interest rate, and a repayment schedule. You also need to actually track and record all repayments. 📁 Without documentation, the IRS has options - and none of them are good for you. They may treat the loan as a distribution (potentially causing distributions in excess of basis), 🏦 or they may reclassify it as wages. 😩 Either way, you lose the tax benefits of treating it as a loan and could owe unexpected taxes. What Happens If Your S-Corp Status Gets DisqualifiedThe consequences of any of these issues can be severe. If the IRS determines your company isn’t truly structured as an S-corp, here’s what you face: Double Taxation: Your company gets taxed as a C-corporation instead. The business pays corporate taxes on all profits. Then when you take money out as an owner, you’re taxed again at your personal level. You end up paying tax twice on the same money. And the small bit about years of back taxes for the C-Corp and your personal return. ☠️ Salary Reclassification: If you didn’t take a real salary, the IRS can reclassify your distributions as wages. Now you owe back payroll taxes on Social Security and Medicare for money you thought was tax-preferred profit. 😡 Add penalties and interest—that number grows fast. Tax on Excess Distributions: If you took out money beyond what you personally invested (especially if it was debt-financed), you’ll owe income tax on that excess, plus penalties and interest. The TakeawayThese problems compound over time. Back taxes, interest, and penalties quickly turn into a serious financial crisis - the complete opposite of what good tax planning is supposed to do. With a few weeks left before the end of the year, time to get to work on these if any of them sound familiar. 🫡 🔥 Hottest Finance Posts This Week 🔥
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I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox 👇 Also on YouTube at PlugAccountingandTax!
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