You've filed an S election - now what? A practical compliance checklist for new S corps

ARTICLE | August 26, 2025

Making the jump to S-corporation status probably wasn’t an impulse decision; you looked at your books, saw profits piling up well beyond the salary you pay yourself, and decided it was time to stop feeding self-employment tax on every extra dollar. 

That strategic shift usually arrives after years of running as an LLC or partnership, and it feels like a reward for doing things right. But the S election is more than a single signature on Form 2553; it brings a new set of rules. Some of those rules, like separating personal and business accounts and tracking basis, may already be second nature. Others, like putting yourself on W-2 payroll and documenting formal minutes, may be new territory. 

Either way, a clear roadmap keeps the election working in your favor and can spare you financial and legal headaches. 

Payroll and reasonable salary

You may have taken owner draws at will in the past, but an S corporation insists that shareholder-employees draw reasonable compensation as W-2 wages. After all, a key benefit of the S election is separating wages from other business profits. 

Tax laws and regulations don’t define reasonable compensation, but examiners will generally consider factors like your duties, hours, credentials, and what comparable businesses pay for similar work. It may help to review industry salary surveys, BLS data, and consider what you’d pay someone else to do your job before setting your compensation. And keep in mind that this isn’t a one-and-done consideration - you’ll need to adjust it as circumstances change. 

If the IRS thinks you low-balled your salary, it can re-characterize prior “dividends” as wages, pile on back payroll taxes, and add failure-to-deposit penalties. The failure-to-deposit penalty starts at 2% when a payment is only a few days late and escalates to 15% if the money is still missing after the IRS sends a demand notice. 

To reduce the risk of compliance issues, research going rates and update your compensation annually, run your paychecks through a bona-fide payroll system, and schedule payroll tax deposit deadlines well ahead of time. 

Tighten your accounting and record-keeping

You’ve likely already separated the business checkbook from your personal wallet, but an S-corp asks for one step more: a living paper trail that can prove, line by line, how every dollar moved. Start by reconciling the books monthly; a clean ledger is what lets you track the two tallies that matter most: stock basis and the accumulated adjustments account.

Basis is your running investment in the company, and the IRS expects each shareholder to compute it every year on Form 7203, which must be attached to the individual return and is often cross-checked against the 1120-S. The accumulated adjustments account records the corporation’s undistributed, previously taxed earnings; keeping it current is what tells you whether the next cash distribution is a tax-free return of capital or a taxable dividend.

Precise bookkeeping also matters for shareholder loans. If you advance money to the company, or borrow from it, track principal and interest separately and memorialize the terms with a signed note; otherwise the IRS may re-label an undocumented loan as a disguised distribution or contribution. Payroll records deserve equal care: federal rules require you to retain Forms W-2, 941, and supporting documents for at least four years after the tax is due or paid, while general business records must be kept long enough to substantiate every item on the return, generally seven years.

Adopt and document corporate formalities

Once your LLC or partnership crosses the line into S-corporation territory, state corporate law may expect you to behave like a “real” corporation, and examiners watch those signals closely. Even if state law doesn’t require you to register as an S-corporation and take the following additional steps, it may be beneficial from a legal standpoint. 

S corps have specific ownership rules, so it’s worth revisiting your shareholder agreements to ensure any transfers won’t affect your new status. S corps are limited to 100 shareholders, all of whom must be U.S. citizens or resident individuals (with very few exceptions, such as certain trusts and estates). Even an accidental transfer of a single share to an ineligible party can terminate the election immediately. 

Issuing numbered share certificates and keeping a stock-transfer ledger may feel ceremonial, yet those records can prove there is only one class of stock, a non-negotiable condition for preserving S status. If you fail to document ownership properly, you invite shareholder disputes, and the IRS can argue that you have more than one class of stock, instantly terminating the S election. 

Bylaws come next. Adopting and occasionally updating formal bylaws demonstrates that decisions are made through a predictable process, a distinction that helps keep the limited-liability shield intact.

Those bylaws should point you to regular shareholder-and-director meetings, complete with minutes. Documenting who approved salaries, dividends, or major contracts closes the evidentiary gap that litigators exploit when they try to pierce the corporate veil or that IRS agents seize on when they suspect distributions are really disguised wages.

Finally, every contract should carry the corporation’s name first and your officer title after your signature. That seemingly small step underscores that the entity, not you personally, is on the hook, reinforcing the separation that limited liability and S-corp tax treatment both rely upon.

Review fringe benefits and owner perks

If you own more than 2% of the company’s stock, company-paid health insurance must appear in Box 1 of your W-2. Doing so enables you to keep the self-employed health-insurance deduction on your individual return. Group-term life over $50,000, most cafeteria-plan perks, and even certain disability policies follow the same rule.

Mind your state and local filings

An IRS S election is a federal filing and doesn’t always bind the states. Some recognize it automatically, others demand their own election form, and a few ignore S status altogether. Also, keep in mind that expanding payroll or sales into a new jurisdiction can trigger a need for registrations you may not have needed as a Schedule C or Form 1065 filer. Work with your advisors to ensure you’re complying with all relevant state and local rules that may apply to your business. 

Plan for new tax filings and deadlines

Your due-date calendar may change as well. The federal return is now Form 1120-S, due the 15th day of the 3rd month after year-end. Each shareholder (even if there is only one) must receive a Schedule K-1 by that same date. Shareholders should also remit quarterly estimated taxes on pass-through income that isn’t covered by withholdings. 

You must file quarterly Forms 941 and an annual Form 940 because wages are now on the board. And don’t forget to file the relevant state payroll returns as well.     

Watch built-in gains and passive-income traps

The one danger that catches many new S-corp owners off guard is the built-in gains tax. If your company ever filed as a C corporation, any asset that was worth more than its tax basis on the day of the election sits in a five-year “cooling-off” window. Sell or liquidate that appreciated real estate, customer list, or even goodwill inside the window, and the corporation, not the shareholder, writes a separate check to the Treasury for the full 21% corporate rate before a penny flows through to your K-1. Keeping a schedule of those legacy assets and their original inside gain is the only reliable way to spot a built-in-gains landmine before you trigger it.

Another tax rule lurks for S corporations that still carry C-corp accumulated earnings and profits on their balance sheet. If more than a quarter of your gross receipts in any year come from passive sources and that happens three years in a row, the IRS first levies a punitive tax on the excess and then ejects you from S-corp status as of the fourth year. The statute is blunt: the election terminates automatically, and you wake up a C corporation again, complete with double taxation on future profits. The cure is simple but requires vigilance: either bleed off the old C-corp E&P with dividends before the third strike, or diversify revenue so operating income always dwarfs passive receipts. A quarterly glance at your income statement keeps the issue from sneaking up in year three.

Your next move

An S election isn’t a “set-it-and-forget-it” trick. It’s a living structure that demands payroll discipline, crisp record-keeping, and legal formality. Nail those basics, and the tax savings will follow; ignore them, and the IRS can claw back every nickel, plus penalties.

Please keep in mind that this article isn’t intended as legal, tax, or accounting advice. It cannot replace a conversation that factors in your company’s specific circumstances, state laws, or the latest regulatory changes. Always run significant moves past your legal and tax advisors. 

If you’re considering or have recently filed an S election, let’s review your payroll and map out your compliance calendar. Contact our office for a meeting, and we’ll make sure your new S-corp status works for you, not against you.