5 S-Corp Mistakes That Cost Business Owners Money

An S-Corp election saves owners real self-employment tax when it runs correctly. It creates audit exposure and lost deductions when it does not.

Here are the five mistakes we see most often in S-Corp returns. Every one is fixable. Most are expensive.

Mistake 1: Paying Yourself an Unreasonable Salary

The S-Corp rule is simple. Owners who work in the business must take a reasonable salary before pulling the rest of the profit as a distribution. Salary pays 15.3% payroll tax. Distributions pay zero.

Pay yourself too little and the IRS can recharacterize distributions as wages, assess back payroll tax, and add penalties. Pay yourself too much and you burn the savings the S-Corp was supposed to capture.

A sole-owner S-Corp with $300,000 in profit and a $60,000 salary saves about $18,000 in self-employment tax every year. Bump that salary to $150,000 and the savings drop to $11,000. Drop the salary to $25,000 and you invite a challenge that can cost you $40,000 or more in back tax and penalties.

Find the right number using comparable wage data for your role, hours, and region. Document how you got there.

Mistake 2: Running Personal Expenses Through the Business

Meals at the ballpark. The family vacation coded as travel. A personal vehicle that never leaves the driveway. An S-Corp return with personal expenses stuffed into it is a gift to an auditor.

Personal expenses in the S-Corp create two problems. The deduction is disallowed, which raises taxable income. And the payment to you gets treated as a distribution, which reduces your basis and can trigger capital gains tax if basis hits zero.

Set up an accountable plan. Reimburse yourself for real business expenses with receipts, mileage logs, and a clear business purpose. Keep the personal stuff out of the business checking account.

Mistake 3: Missing the Health Insurance W-2 Step

Self-employed health insurance is deductible for S-Corp owners, but only if you follow the exact mechanic. The S-Corp pays the premiums. The amount gets added to the owner's W-2 as wages in Box 1. The owner then deducts the amount on the personal return as a self-employed health insurance adjustment.

Skip the W-2 add-back and you lose the deduction. Skip the personal deduction and you pay tax on the same dollar twice. For a family paying $24,000 a year in premiums, that mistake costs about $7,000 in federal tax.

Your payroll provider can handle it if you ask before the final payroll of the year.

Mistake 4: Missing the Election Deadline

Form 2553 is due by March 15 of the year the election takes effect, or within 75 days of forming the entity for a new business. Miss the deadline and the S-Corp treatment does not start until the following year.

Late election relief exists under Rev. Proc. 2013-30, but it requires a reasonable cause explanation and clean compliance. Better to file on time.

If you are starting a new business or thinking about an election for next year, put the deadline on the calendar now.

Mistake 5: Not Tracking Basis

Every dollar you put into the S-Corp adds to your basis. Every dollar of loss or distribution reduces it. When your basis hits zero, any further distribution becomes a taxable capital gain, and any further losses get suspended until you have basis to cover them.

Most S-Corp owners never see a basis schedule because their accountant does not prepare one. Five or ten years in, the shortfall can be large enough to trigger a surprise tax bill on a distribution that felt routine.

Ask your CPA for a basis schedule with every return. If they cannot produce one, that is the sixth mistake.

What to Do Next

Pull your last S-Corp return. Look for salary level, distributions, any personal-looking expenses, the health insurance add-back, and a basis schedule. If any of the five mistakes show up, fix them before this year closes.

An S-Corp that runs correctly saves most owners $15,000 to $30,000 a year. That number is worth the ten minutes it takes to check.