S Corp Compliance: 3 Requirements You Need to Understand

As an entrepreneur, you wear many hats. You’re a salesperson, an innovator, an administrator… and a payroll manager?

Whether or not you’re new to S Corp operations, payroll processing can feel like a time-consuming and high-stakes process where the requirements are finicky, the rules complex, and the consequences of missteps sky-high. 

So, how can you manage your S Corp compliance without tearing your hair out?This post will walk you through the top three requirements you need to understand to maintain S Corp compliance and manage your S Corp payroll easily. 

S Corp Compliance Basics

An S Corp is a legal business structure that meets specific Internal Revenue Code requirements. It’s common among small businesses as an alternative to an LLC. S Corp status offers a corporation’s benefits and a partnership’s tax-exempt privileges.

Unlike a C Corp, an S Corp can pass income, losses, and deductions directly to shareholders and avoid paying federal corporate taxes. It’s an attractive option for many entrepreneurs and small businesses.

There are more advantages:

• Business owners pay less income tax by taking a salary or dividends, lowering their liability for self-employment tax.
• Shareholders can transfer interests and adjust property basis without facing tax consequences.
• Registering as an S corporation might build credibility with customers, employees, and investors.

There are, however, some missteps to avoid when managing S Corp payroll, including:

• Neglecting an accountable plan: Establish a plan for you (the employee) to shift the deductibility of your business expenses to your S Corp (the employer), so you can mitigate personal tax liability.
• Forgetting health insurance premiums: If you don’t fill out your tax return correctly, you’ll be subject to social security and Medicare taxes.
• Over- or underusing home office deductions: Don’t miss out on deductible expenses if your home is your principal place of business.
• Paying yourself too much (or too little): Don’t neglect the process of paying yourself a reasonable salary.
• Missing payroll tax payments: If you’ve set a salary, ensure you process payroll to pay yourself.

Related: 5 Missteps in Single Owner S Corp Payroll (And How To Avoid Them)

If you want to speak to an expert about S Corp payroll, avoid the missteps above, and set your business up for success, schedule a call with a ConnectPay Payroll Specialist!

1. Structuring Requirements

Not all corporations qualify for S Corp status. You have to meet specific requirements according to the Internal Revenue Code.

You’ll need to be incorporated within the United States, have only one class of stock, and you can’t have more than 100 shareholders. Your shareholders must meet eligibility requirements; they must be individuals, a specific trust or estate, or tax-exempt organizations.

You’ll need to maintain your status to remain compliant as an S Corp. This includes ensuring you have all the proper documents, pay your filing fee, and complete procedures for renewing your S Corp each year. Failure to complete this filing can result in your corporation being dissolved.

Ensure you use your corporate name on all legal documents and your website. It’s easy to forget and use your name, but you want customers and vendors to know that your company is doing business and you’re an officer of the corporation.

2. Entity Filing and Tax Requirements

An S Corp business structure allows your business to avoid double taxation, but to maintain S Corp status; you’ll need to ensure that you file the correct forms and prove that you’re eligible to operate as an S Corp. You’ll also need to stay on top of your tax return filing to reduce the chances of an audit.

What to do:

• File Form 2553 with the IRS
• Consider any state-specific forms and taxes
• File an annual tax return with your S corp: Form 1120-S, to report your income, deductions, and payments

Setting up your payroll procedure is the easiest way to stay on top of tax requirements. You need to pay yourself a reasonable salary, trying to strike a balance between overpaying and underpaying yourself. You’ll pay more than necessary in self-employment taxes if you overpay yourself. Conversely, if you underpay yourself, you risk an IRS audit.

When you partner with a payroll provider, you can easily set up a payroll schedule, make monthly payroll tax payments, and partner with local tax experts and connections to help you run your S Corp payroll processes easily.

Related: Ways payroll frequency can save you money | ConnectPay

3. Shareholder Requirements

The IRS sets forth strict shareholder requirements that you must follow. 

• You can’t have more than 100 shareholders. 
• Your shareholders must meet eligibility requirements; they must be individuals, a specific trust or estate, or tax-exempt organizations. 
• They can’t be partnerships or other corporations.
• Shareholders must unanimously consent to electing S Corp status.

Shareholders can be compensated in two ways. They can receive corporate income as salary or dividend distribution. Salaries are subject to payroll and personal income taxes; distributions are only subject to personal income tax.

To remain compliant, your best bet is to partner with a payroll provider or tax attorney. S Corps need more oversight to ensure you don’t pay out too many distributions instead of salaries. Bookkeeping is essential, and knowing the differences in federal and state tax regulations is a must.

Maintaining S Corp Compliance The Easy Way

Managing your S Corp while maintaining compliance with IRS regulations and requirements can feel overwhelming, but it doesn’t have to. Following the advice in this guide will set you up for success in managing your S Corp payroll and processes.

However, following these steps manually can be tedious and error-prone. You may want to consider partnering with an experienced S Corp payroll provider to ensure you’re setting your business up for success.

Schedule a call with a ConnectPay Connected Service Representative today to see how our solution can help you easily manage your S Corp compliance.