7 Horrible Mistakes You’re Making With Your S-Corporation

The business structure, S-Corporation, is one of the most complex business types that small business owners love, but may not fully understand how to properly operate from a tax compliance standpoint. This article discusses the top mistakes we see business owners making with their S-Corporation. Our list is not in any special order, all seems to be commonly made.

1. Disguising compensation as loans to the shareholder

Many S-Corporation owners are aware of their responsibility to pay themselves reasonable compensation but due to various reasons, may decide not to follow this rule. Instead, withdrawals of cash may be incorrectly stated as a loan to an officer. Often times, there’s not even a loan agreement put in place to make this type of transaction even look legitimate.

2. Shareholder-employees taking low salaries

So maybe, you’re not as extreme as the prior example, but decide to pay yourself a small amount of compensation for the year. For example, a business owner (not you of course!) decides to pay themselves $10K for the year, but has a secretary who they have paid $25K for the year. In this case, the IRS would certainly consider your compensation to be unreasonable given that your duties are much more involved than the services rendered by your secretary and often times is needed for the business to even operate. Check out our article, “Reasonable Compensation: What No One is Talking About” to gain an understanding of how reasonable compensation is determined.

3. S-Corporation making “gifts” to shareholder-employees

To avoid payroll taxes, some shareholder-employees may be given compensation disguised as gifts. Payments like these can easily be “recharacterized” by the IRS if found and treated as wages. Be sure to look at the rules for giving gifts to employees to avoid this mistake.

4. Making your S-Corporation pay a more than 2% shareholder’s health premiums without adding this to their compensation

If you are more than a 2% owner in your S-Corporation, any fringe benefits you give to yourself from your company is considered compensation and must be added to your paycheck as income. If your company pays your health insurance, this amount must be added in your payroll as compensation,
however, you are able to deduct 100% of your health insurance premiums as a deduction from your income on your personal tax return.

5. Paying very high salaries to shareholders who are in low income tax brackets

If the bulk of your S-Corporation’s ownership is owned by employees in a low tax bracket and you, the only shareholder-employee are in a high tax bracket
and you pay yourself a very low salary, while the other employees are paid ultra high salaries, this could be a recipe for disaster.

6. Making a difference in the share of profit and loss when compared to the actual amount of ownership in your S-Corporation

S-Corporations may only have one class of stock besides having voting and non-voting shares. You could be considered as creating another class of stock
if you and another owner own your S-Corporation on a 50/50 split, but decide to issue out a share of the profits on a 60/40 split, for example. Profits must be split on the basis of your ownership only. If split otherwise, you will jeopardize your S-Corporation status.

7. Underestimating the cost of not paying reasonable compensation

When wages are paid, social security and medicare taxes are withheld from this pay and helps give you the credits necessary to earn Social Security
benefits at retirement. Social Security income is exempt from bankruptcy and helps against the concern of living too long and running out of money.