Your Guide to Accounting For S-Corps

No more double-taxation for you! You’ve converted your business to an S-Corp and can now enjoy the benefits of being a “pass-through entity.” 

The biggest wins for you? No more self employment taxes, your personal assets are protected thanks to limited liability, and you now have an array of accounting options in front of you.

Having more options isn’t always better, though. Accounting for S-Corps has its share of rules you must follow. Otherwise, you might risk discontinuation of your S-corp status.

So what do you need to know? Here are a few best S-Corps accounting practices to be aware of:

Paying Yourself As An S-Corp Owner

One of the biggest reasons for converting to an S-Corp is to avoid  self-employment tax rates. If you previously taxed as a sole proprietor on a Schedule C, you are already painfully familiar with these taxes.

With your newly-filed S-Corp, you’re now able to pay yourself a reasonable salary. In doing so, your company will be subject to paying payroll taxes on the amount you pay yourself. You will also withhold federal and state taxes to be applied to your total tax liability from your personal tax return. 

The payroll taxes that your company pays in your W2 income is a tax-deductible expense for your company, reducing your overall taxable income. You may also be able to take cash distributions from your company.

While this might seem like a great way to reduce your taxes, it might be the first trap you fall into that gets your S-Corp terminated.

To avoid that, resist giving yourself a less than reasonable  salary and then picking up the rest in distributions. The IRS can and will catch on if you’re underpaying yourself. 

This is based on their discretion since there is no clear-cut amount you must pay yourself as an S-Corp owner, so you’ll want to be sure to pay yourself an amount that is in line with what you might pay someone else to do your job. Your bookkeeper or tax professional can help you understand what you can afford to pay yourself and, as always, consult your tax professional before making entity changes. They can give you tax advice and best practices.

Opening A Business Bank Account For Your S-Corp

The next item you want to check off your list as an S-Corp is opening a business bank account. To do so, you’ll need your Tax ID or Federal Employer Identification Number. Choose whatever bank suits you, whether it’s based on location, online ease of use, or customer service ratings. 

You can even use a credit union if banks are not your style. 

Opening a separate bank account will require the basics: some form of ID, an initial deposit, and the aforementioned Tax ID. For your business, you might further need to show your incorporation documents as well as your bylaws, stock and shareholder certificates, and proof of S-Corp status. 

Be sure to keep all personal banking separate from the business’ account, regardless of whether your new company is based around you as an entrepreneur. If you’ve ever had an LLC, this won’t be news to you. 

However, if you’re moving out of a single-member LLC into an S-Corp, what’s new is that legally, the business is a separate entity. You will need to keep its financial books distinct from any personal transactions. 

Commingling personal and business transactions is a bad practice. It opens you up to personal investigation in the case of an audit. 

Various Methods Of Accounting For S-Corps

Speaking of books, S-corps give you a wider range of options when it comes to managing your finances. While other corporations are tied down to using the accrual-based method of accounting, S-corps are allowed to use the cash method or a blended method of your choosing. 

Managing Shareholders’ Capital Within S-Corps

While this makes things easier, there is the slightly complicated matter of shareholder accounting for S-Corps. You must meticulously keep a capital account for each of your shareholders since this will determine their distribution payout.

Here are 5 things to keep in mind:

1. Shareholders can make both cash and property investments (both listed as equity on the balance sheet).

2. Shareholders can give loans to the corporation, which will be listed as S-corp debt. 

3. These become the shareholders’ current basis and are written in their capital account.

4. Alternatively, you (or your accountant) might choose the fair market value of the investment to put on the shareholders’ capital accounts.

5. Shareholders might later have an “adjusted basis,” which takes into account any changes in investments during the accounting year.

Bookkeeping For S-Corps

Diligently maintaining the financial records of your newly founded S-Corp is crucial for many reasons, including to:

1. Make informed financial decisions.

2. Prepare sound financial reports. 

3. Be ready for audits.

4. File accurate taxes.

Bookkeeping isn’t everyone’s jam, though, and the best practice is to outsource this service to someone who specializes in your industry or type of business. By doing so, you can also get expert advice on cash flow and forecasting that will help you responsibly grow your business. 

Taxation For S-Corps

We’ve returned to the very reason you likely adopted S-Corp status in the first place. No double taxation.

Here are the basics:

  • You must file the 1120S tax form to outline your S-Corp’s income and expenses. 
  • Your employees must be w2 workers, which means payroll taxes.
  • You may also need to pay city, county, or state taxes depending on your location.
  • Even if you have no net income, you must still file a return. 

Distribution to S-Corp Shareholders

Till now, we haven’t used the term “dividends” when speaking about accounting for S-Corps. Typically, dividends refer to the amount your shareholders regularly receive from profits at the end of a set period.

With S-Corps, dividends are replaced by the word distribution, which we’ve mentioned a couple of times now. Remember, you and your shareholders earn both profits and losses based on their investments. Therefore, distribution is a better word here.

More specifically, the phrase you’ll use to do your accounts should be “distribution of earnings and profit.”

Your Options When Accounting For S-Corps

There’s no reason to be intimidated by the accounting side of S-Corps. Once you know what makes them different from other entity types, you’ll be on your way to decreased taxes and a healthy set of financial books.

Still, you might get lost along the way. If you feel a bit overwhelmed and need someone to guide you to successful accounting for S-Corps, book a call with us today!