S‑Corporation Tax Guide for Owners

Overview

Starting and running an S corporation brings two parallel tax compliance tracks: federal pass‑through income reporting and employment/payroll tax obligations. Getting organized early on—entity election, required filings, shareholder compensation, payroll, and (where applicable) state‑specific rules—will help you avoid penalties and keep your records clean. Below is a practical roadmap for S‑corp owners to get started, with authoritative citations to the Internal Revenue Code, Treasury regulations, IRS guidance, and California state resources where relevant.

Step 1: Confirm S corporation eligibility and make (or maintain) the S election

• An S corporation is a “small business corporation” (domestic, allowable shareholders, no more than 100 shareholders, one class of stock, not an ineligible corporation) for which an election under section 1362 is in effect for the taxable year. See IRC § 1361 IRC § 1361 and Treas. Reg. § 1.1361 Treas. Reg. § 1.1361‑1:

  • IRC § 1361 IRC § 1361: https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section1361

  • Treas. Reg. § 1.1361 Treas. Reg. § 1.1361‑1: https://www.ecfr.gov/current/title-26/section-1.1361-1

• The election to be an S corporation is made on Form 2553; all shareholders on the day of the election must consent, and timing rules apply (generally by the 15th day of the third month for the year to be effective). See IRC § 1362 IRC § 1362 and Treas. Reg. § 1.1362 Treas. Reg. § 1.1362‑6:

  • IRC § 1362 IRC § 1362: https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section1362

  • Treas. Reg. § 1.1362 Treas. Reg. § 1.1362‑6: https://www.ecfr.gov/current/title-26/section-1.1362-6

  • Form 2553 (overview and instructions): https://www.irs.gov/forms-pubs/about-form-2553 and https://www.irs.gov/pub/irs-pdf/i2553.pdf

• If an S election terminates (e.g., an ineligible shareholder or passive investment income with accumulated earnings and profits triggers termination), re‑election is restricted for five taxable years unless the Secretary consents (IRC § 1362 IRC § 1362).

• IRS overview on S corporations: https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations

Step 2: Understand the effect of S status and annual filings

• S corporations generally aren’t subject to federal corporate income tax; income, losses, deductions, and credits flow through to shareholders, though certain entity‑level taxes (e.g., on built‑in gains and excess net passive income) can apply (IRC § 1363 IRC § 1363):

  • IRC § 1363 IRC § 1363: https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section1363

  • IRS overview: https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations

• File Form 1120‑S by the 15th day of the third month after the end of the tax year (for calendar year S corps, March due date; extensions via Form 7004 are available). Provide each shareholder with Schedule K‑1 reflecting their pro rata items. E‑filing rules and thresholds apply:

  • Instructions for Form 1120‑S: https://www.irs.gov/forms-pubs/about-form-1120-s and https://www.irs.gov/pub/irs-pdf/i1120s.pdf

  • W‑2/W‑3 e‑file guidance and thresholds: https://www.irs.gov/pub/irs-pdf/iw2w3.pdf

• Publication 542 provides general corporate guidance that supplements Form 1120‑S instructions, including filing and paying, penalties, and estimated tax context:

  • Pub. 542: https://www.irs.gov/forms-pubs/about-publication-542

Step 3: Pass‑through reporting, shareholder basis, and distributions

• Shareholders report their pro rata share of S‑corp items on their returns; losses and deductions are subject to basis, at‑risk, and passive activity limitations (IRC § 1366 IRC § 1366):

  • IRC § 1366 IRC § 1366: https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section1366

• Stock basis increases for income and decreases for distributions and certain deductions; debt basis adjustments and ordering rules apply (IRC § 1367 IRC § 1367; see Schedule K‑1 shareholder instructions for mechanics):

  • IRC § 1367 IRC § 1367: https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section1367

  • Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S): https://www.irs.gov/instructions/i1120ssk

  • Treas. Reg. § 1.1367 Treas. Reg. § 1.1367‑1 and § 1.1367‑2 (basis and debt basis rules): https://www.ecfr.gov/current/title-26/section-1.1367-1 and https://www.ecfr.gov/current/title-26/section-1.1367-2

  • Treas. Reg. § 1.1366 Treas. Reg. § 1.1366‑2 (debt basis creation and limits): https://www.ecfr.gov/current/title-26/section-1.1366-2

• Distributions follow the accumulated adjustments account (AAA) ordering: portions may be tax‑free to basis, dividend to the extent of accumulated earnings and profits, then gain; coordination rules are in § 1368:

  • IRC § 1368 IRC § 1368: https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section1368

Step 4: Pay yourself correctly—officer wages and reasonable compensation

• Corporate officers are generally employees. Paying yourself solely via distributions risks recharacterization; the IRS expects wages subject to employment taxes for services performed. Reasonable compensation depends on facts and circumstances (duties, time devoted, comparables, etc.):

  • S Corporation Compensation & Medical Insurance Issues: https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues

  • IRS “Paying yourself” overview: https://www.irs.gov/businesses/small-businesses-self-employed/paying-yourself

• Health insurance premiums for >2% shareholder‑employees are treated as wages for income tax withholding (not FICA/FUTA), with special deductibility rules outlined in the guidance above.

Step 5: Set up payroll and comply with federal employment tax rules

• Withhold and deposit federal income tax, Social Security, and Medicare taxes; employers pay the employer share of FICA and FUTA. Use EFTPS (or approved electronic methods) and follow monthly/semiweekly deposit schedules:

  • Pub. 15 (Employer’s Tax Guide): https://www.irs.gov/forms-pubs/about-publication-15

  • Depositing and reporting employment taxes: https://www.irs.gov/businesses/small-businesses-self-employed/depositing-and-reporting-employment-taxes

• File Forms 941 (quarterly), 940 (annual FUTA), Forms W‑2/W‑3 with SSA, and any Form 945 for nonpayroll withholding, by required due dates. Employers filing 10 or more information returns must e‑file:

  • Employment tax due dates: https://www.irs.gov/businesses/small-businesses-self-employed/employment-tax-due-dates

  • W‑2/W‑3 instructions (e‑file rules): https://www.irs.gov/pub/irs-pdf/iw2w3.pdf

Step 6: California notes (if applicable)

• California taxes S corporations at 1.5% of net income and imposes an $800 minimum franchise tax (with certain first‑year exemptions); file Form 100S by the due date:

  • FTB S corporations overview: https://www.ftb.ca.gov/file/business/types/corporations/s-corporations.html

  • Form 100S (current year): https://www.ftb.ca.gov/forms/

• California estimated tax for S corporations has specific installment percentages and rules; see Form 100‑ES instructions for rates, due dates, and minimum franchise tax timing:

  • Form 100‑ES instructions (current year): https://www.ftb.ca.gov/forms/

• California SDI (State Disability Insurance) sole‑shareholder/corporate officer exclusion: a corporate officer who is the sole shareholder (or the only shareholder other than spouse) may elect out of SDI/Paid Family Leave coverage. File the DE 459; the exclusion is effective the first day of the calendar quarter in which filed and remains for the year filed plus two succeeding complete calendar years (and subsequent quarters) until withdrawn or terminated by ownership/status changes. This exclusion applies only to SDI—UI/ETT and federal FUTA rules still apply. Follow DE 9/DE 9C reporting procedures and plan code “R” designations when required:

  • DE 459: https://edd.ca.gov/siteassets/files/pdf_pub_ctr/de459.pdf

  • DE 9 and DE 9C (quarterly payroll returns): https://edd.ca.gov/en/payroll_taxes/forms_and_publications/

  • SDI program overview: https://edd.ca.gov/en/payroll_taxes/state_disability_insurance_faqs/

Step 7: Keep strong records and calendars

• Maintain books sufficient to support pass‑through items, shareholder basis changes, distributions, and payroll compliance (including officer compensation rationale). Schedule K‑1 instructions emphasize tracking basis and loss limitations; failure to do so can cause disallowed losses and IRS adjustments:

  • Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S): https://www.irs.gov/instructions/i1120ssk

• Calendar federal and state filing/deposit deadlines (Forms 1120‑S, 941/940, W‑2/W‑3, state returns and payroll filings):

  • Employment tax due dates: https://www.irs.gov/businesses/small-businesses-self-employed/employment-tax-due-dates

Quick checklist to get started

• Validate S‑corp eligibility and submit/confirm the § 1362 S election; gather shareholder consents:

  • IRC § 1362 IRC § 1362: https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section1362

  • Treas. Reg. § 1.1362 Treas. Reg. § 1.1362‑6: https://www.ecfr.gov/current/title-26/section-1.1362-6

• Set up accounting to produce Form 1120‑S and Schedules K‑1 annually; understand the pass‑through nature of items and shareholder basis rules:

  • Instructions for Form 1120‑S: https://www.irs.gov/pub/irs-pdf/i1120s.pdf

  • IRC § 1367 IRC § 1367: https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section1367

• Establish payroll with reasonable officer wages; register for payroll accounts, implement withholding/deposits, and track deadlines (Forms 941, 940, W‑2/W‑3):

  • Paying yourself: https://www.irs.gov/businesses/small-businesses-self-employed/paying-yourself

  • Pub. 15: https://www.irs.gov/forms-pubs/about-publication-15

• If in California, set up state corporate and payroll accounts, file Form 100S, pay the 1.5% tax and minimum franchise tax, consider DE 459 SDI exclusion if eligible, and follow DE 9/DE 9C reporting rules:

  • FTB S corporations overview: https://www.ftb.ca.gov/file/business/types/corporations/s-corporations.html

  • DE 459: https://edd.ca.gov/siteassets/files/pdf_pub_ctr/de459.pdf

• Document basis, distributions, officer compensation, and payroll records; provide shareholders timely K‑1s and retain proof of filings and deposits:

  • Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S): https://www.irs.gov/instructions/i1120ssk

  • Depositing and reporting employment taxes: https://www.irs.gov/businesses/small-businesses-self-employed/depositing-and-reporting-employment-taxes

Final thoughts

S‑corp compliance is manageable when you set clear processes for pass‑through reporting, compensation, and payroll—and align federal and state requirements from the outset. Keep an eye on qualification standards, timely elections, officer wage policies, and robust recordkeeping; these are the backbone of a clean S‑corp compliance profile:

• IRS S corporations overview: https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations

• Instructions for Form 1120‑S: https://www.irs.gov/pub/irs-pdf/i1120s.pdf

This essay is not tax advice. Always consult a qualified tax professional for your specific situation.