Electing S‑corp status can drop thousands off your tax bill— but only if you get the timing, paperwork, and after‑election housekeeping right. Use the notes below from our Partner, Joe Gallegos, CPA as a practical checklist before you file Form 2553.
1. Don’t Rush the Decision
Give your business at least a few months of steady revenue before you pull the trigger. Once you’re an S‑corp you’ll have payroll, quarterly filings, and state fees to deal with—costs that can wipe out any savings if profit is still thin or volatile. For example, if your business is going to report a net loss – being a S corporation does NOT result in greater tax savings.
2. Make Sure the Math Works
In most service businesses the election doesn’t pay for itself until net profit is roughly $80,000–$100,000 a year. Below that, the payroll and compliance spend often equals or exceeds the SE‑tax savings. A rule of thumb method I use to estimate S corporation tax savings is to take the net income and multiply by 15.3% and then multiply that by 50%. For example, $30,000 x 15.3% = $4,590; $4,590 x 50% = $2,295. With that in mind, consider that S corporation compliance cost can be anywhere between $4,000-$7,000 annually which makes it easy to see why you to be at a certain level of net profit to recognize true cash savings from being in a S Corp if you plan to use a Professional to help.
3. How the Tax Savings Really Happen
Only the salary you pay yourself as a W‑2 employee is subject to the 15.3 percent Social Security/Medicare tax. Profits you take as distributions are not—so carving off a portion of earnings as “dividends” (after paying yourself a reasonable wage) is the heart of the strategy.
4. The “Reasonable Salary” Rule
The IRS expects owner‑operators to pay themselves market wages. A quick rule of thumb: start with 40–50 percent of net profit as W‑2 wages, then fine‑tune based on your role, industry pay surveys, and hours worked.
5. Solo Owner? Consider a Year‑End “Paper Payroll”
If you’re the only worker, you can often file zero‑liability payroll returns for Q1–Q3 and run one actual payroll in December. That satisfies the W‑2 requirement while keeping bookkeeping simple. For more information about running a year-end paper payroll, see here.
6. Missed the Deadline? All Is Not Lost
7. Partnerships Lose Their Flexibility
Inside an S‑corp everything—income, deductions, even some state tax credits—must be split strictly according to ownership percentage. If you need special allocations or preferred returns, stick with partnership/LLC taxation.
8. Asset Distributions Can Get Expensive
Passing out appreciated property (including equipment or real estate) often triggers taxable gain inside the S‑corp and on the shareholder return. Leasing the asset to the entity instead of transferring title is usually safer.
9. Budget for Estimated Taxes
Because most owners bunch payroll into the fourth quarter, withholding alone rarely covers the full liability. Decide up front whether you’ll make quarterly estimates or sock away cash for a single year‑end payment.
10. Timing Trap: Electing Near the Extension Deadline
Form 1120‑S can be put on extension to September 15, but Form 2553 cannot. If you fax or mail the election after March 15 (or two‑months‑plus‑15‑days after start‑up) it will look “late” to the IRS computers once the 1120‑S arrives, and you’ll likely receive a CP264 notice disallowing the election.
What to do if the notice comes:
Keep your proof. Save the fax confirmation or certified‑mail receipt that shows the original send date.
Respond quickly. Draft a short letter within 30 days referencing Rev. Proc. 2013‑30, attach the proof, and ask that the notice be withdrawn.
Follow up by phone if you don’t see an acceptance letter (CP261) within 60 days.
A little paper trail now saves a lot of anxiety later.
11. First‑Time Penalties Are Usually Waived
If a return or payroll report does end up late, the IRS offers one‑time administrative relief for businesses with clean compliance histories. A concise request citing “first‑time abatement” is normally enough.
12. Late S Election + No (or Too Low) Salary: Practical Paths—From “Clean Fix” to “Patch”
Before choosing a path, remember two non-negotiables:
Officers are employees. For S-corps, the IRS expects reasonable W-2 wages before non-wage distributions; otherwise, they can reclassify distributions, dividends, or “loans” into wages.
Late election relief doesn’t waive payroll rules. You can backdate the S election, but you still need wages for services in the covered period.
Option A — Full Compliance Correction (Best Practice)
What you do now
Determine a reasonable compensation figure for the affected period (based on role, hours, and market comps).
If it’s the current year and W-2s aren’t filed yet, run a catch-up payroll before 12/31.
If it’s a prior year, reclassify enough distributions to wages and file Form 941-X for each quarter (and Form 940 if needed). Issue corrected W-2/W-3 forms, and pay employer/employee FICA plus interest. Amend the 1120-S/K-1s if amounts change.
Why it’s defensible
This mirrors exactly what the IRS requires: wages first, distributions second.
What might happen
Typically closes the issue cleanly.
Penalties for late payroll filings can often be waived with reasonable cause or first-time abatement.
Failure-to-deposit penalties may still apply (2%–15% depending on lateness).
Option B — Fix Forward Only (No Prior Year Amendments)
What you do now
Start paying a documented reasonable W-2 salary immediately.
Put a written salary policy in place and support it with duties, hours, and market data.
Why clients choose it
Lower cash and administrative burden today.
Gets you compliant going forward.
What might happen
Prior years remain exposed.
If examined, the IRS can still reclassify past distributions and bill payroll tax, penalties, and interest.
Risk level: Medium. Safer if there were minimal distributions or services.
Option C — “1099 Patch” on the Shareholder’s Personal Return
(Not recommended, but here’s the reality)
What some clients ask for
Issue a Form 1099 to the shareholder and pick it up on the 1040 to “show tax was paid.”
The compliance problem
Officers are employees by statute. You can’t simply decide to issue a 1099 instead of a W-2.
What likely happens if examined
IRS reclassifies the 1099 amounts back to W-2 wages at the corporate level.
The S-corp still owes employer FICA, deposit penalties, and interest.
The shareholder may have to amend their personal return to unwind self-employment tax.
Net effect: you may end up paying twice until corrected.
Risk level: High. These arrangements are routinely reclassified.
Option D — File As Is and Do Nothing
What you do now
File 1120-S with $0 officer wages and keep distributions as distributions.
What might happen
Highest exam risk if there’s meaningful profit and distributions with no wages.
IRS can reclassify distributions, assess payroll tax, penalties (2%–15%), and interest.
You’ll still need to issue late W-2s and reconcile payroll returns.
Quick Triage: Which Path Fits?
Current year; W-2s not filed yet: Option A (catch-up payroll before 12/31). Cleanest and fastest.
Prior year with distributions: Option A (941-X remediation). Textbook repair; request penalty relief if history is clean.
Cash-constrained: Option B (fix forward). At minimum, but be clear that prior years remain open to reclassification.
Client insists on a “1099 patch”: Explain Option C’s risks and document acknowledgment of likely IRS challenge.
Bottom Line
The S‑corp election is a powerful tool, but it isn’t one‑size‑fits‑all. Run the numbers, keep immaculate paperwork, and file early in the year whenever you can. Nail those three points and you’ll capture the tax savings without the headaches. If you would like to talk to one of our experts today, please schedule a constulation.
Joe is a Certified Public Accountant (C.P.A.) and a Certified Valuation Analyst (C.V.A.). Joe’s professional career in public accounting began in 2012 with one of the “Big 4” international accounting firms. Since 2012, the focus of his professional engagements has been primarily in the area of business tax planning, cash flow planning and management, business valuations, and small business financial consulting.
