Filing your S-corporation election marks a strategic move—often after years of operating as an LLC or partnership. But while the tax benefits are real, S status also introduces a new set of responsibilities. Here’s a streamlined checklist to help you stay compliant and maximize your election.
1. Operating Agreement ASAP
If your company was an LLC, ideally you will have put an operating agreement in place prior to conversion. However, if this wasn’t done before becoming an S-Corp, then it’s crucial to put this in place quickly, as having an agreement that still reads like a partnership could invalidate your selection.
2. Establish a Reasonable Salary
As an S-Corp owner-employee, you’re required to take a “reasonable” W-2 salary. There’s no strict formula, but the IRS expects your pay to reflect your role, hours, experience, and industry standards. Underpaying yourself can result in reclassified income, back taxes, and penalties. Review annually and process payroll through a compliant system to stay ahead.
3. Sharpen Your Books
Clean accounting isn’t optional.
- Track your stock basis (your investment in the company) and maintain an Accumulated Adjustments Account (AAA) to differentiate taxable dividends from return-of-capital distributions.
- Advance or borrow company funds? Paper the transaction with a signed loan agreement and keep interest and principal separate.
- And don’t forget: wage records (W-2s, 941s, etc.) must be retained for at least four years; most business records for seven.
4. Maintain Corporate Formalities
If the entity converts to an S-Corp but doesn’t legally become a corporation, the focus should primarily be on the operating agreement (see #1 above). However, if your entity is now legally a corporation, you’ll need to operate like one including:
- Holding and documenting annual meetings
- Maintaining bylaws and board resolutions
- Issuing share certificates and track ownership
- Signing contracts with your officer title, not as an individual
5. Review Fringe Benefits
If you own more than 2% of the company, certain benefits like health insurance and group life coverage must be reported on your W-2. This ensures eligibility for personal deductions and avoids compliance missteps.
6. Align State and Local Filings
Your S election is federal—state treatment varies. Some states require their own elections; others don’t recognize S status at all. Expanding into new jurisdictions can also trigger new registration requirements, so it’s critical to work with your advisors to stay current.
7. Know Your Filing Deadlines
Your new filing calendar includes:
- Form 1120-S (due March 15)
- Schedule K-1s for each shareholder
- Quarterly payroll filings (Forms 941 and state equivalents)
- Estimated tax payments on pass-through income
8. Watch for Built-in Gains and Passive Income Risks
If your business converted from a C–corp, selling appreciated assets within five years can trigger a Built-in Gains Tax—even under S status.
9. Beware of Retained Earnings
S-corps with C-corp retained earnings and too much passive income (e.g., rent, royalties) risk losing S status after three consecutive years. Stay proactive with income planning and regular financial reviews.
Aldrich Insights
If you’ve recently elected S-Corp status or are evaluating the option, now is a good time to review your compliance requirements and ensure key processes are in place. Taking a proactive approach and working with an advisor can help avoid surprises down the road.
