Messy books
S Corporation Books That Were Never Kept Like an S Corporation
The election was made and the books carried on as if nothing had changed. An S corporation has rules about owner pay, distributions and the balance sheet that a sole proprietor’s books never needed.
What goes wrong
- The owner took money out all year and no payroll was ever run
- Owner draws recorded as wages, contract labor or a general expense
- Personal spending paid by the company and recorded as a business expense
- Owner health insurance paid by the company and never put through the owner’s W-2
- Money the owner put in recorded as income, or as a loan with no terms
- No balance sheet at all, on an entity whose return generally includes one
- Retained earnings and equity that do not agree with the prior year’s return
- No record of each shareholder’s basis
Any one of these can change the tax on the return. Together they are the reason S corporation books cost more to clean up than a sole proprietor’s.
Owner pay is the center of it
An S corporation owner who works in the business is expected to be paid a reasonable salary through payroll, with payroll taxes withheld and filed, before taking distributions. Money taken out without payroll is the most common problem we find, and it is the one the IRS looks for.
Where payroll was missed for past periods, the options and their costs are looked at before anything is filed. See S-Corp reasonable salary, S-Corp payroll requirements and behind on payroll taxes.
How we clean it up
- Start from the balance sheet on the last filed return and make the books agree with it
- Separate everything paid to or for the owner into wages, distributions, loan activity and reimbursements
- Move personal spending out of expenses
- Record contributions and shareholder loans properly, with terms where a loan is real
- Reconcile payroll in the books to the payroll returns filed
- Rebuild each shareholder’s basis year by year
- Produce a balance sheet that carries forward cleanly
Basis is worth the effort. It decides whether distributions are taxable and whether a loss can be deducted, and it is far harder to reconstruct later. See S-Corp distributions and basis.
If the election was not the right call
Sometimes the cleanup shows the business is not earning enough for the election to pay for its own compliance. We will tell you. The S-Corp savings calculator shows the cost side, and revoking an S-Corp election covers the way out. Our S-Corp setup page covers running one properly.
Frequently asked questions
I took money out of my S corporation without running payroll. What now?
It needs to be dealt with, because an owner who works in the business is expected to receive a reasonable salary through payroll. The approach depends on which periods are involved and what has been filed. We review it with the rebuilt books and set out the options before anything is filed. See S-Corp payroll requirements.
Are owner distributions a business expense?
No. Distributions come out of equity and do not reduce the company’s profit. Recording them as an expense understates income on the return. Wages paid to the owner through payroll are an expense; distributions are not.
Why does my S corporation need a balance sheet?
The S corporation return generally includes a balance sheet, and each year has to begin where the last one ended. A balance sheet is also where loans, owner money and equity are recorded, and those are the items most often wrong.
What is shareholder basis and why does it matter in a cleanup?
Basis is a running total of what you have invested in and left in the company. It decides whether a distribution is taxable and whether you can deduct a loss. It has to be tracked from the first year, so a cleanup rebuilds it year by year. See S-Corp distributions and basis.
Not the question you had? The full tax FAQ covers more ground, and our client reviews say what the work is actually like.
Related situations and guides
Loans and owner money booked wrong
Loan deposits as income, repayments as expenses, draws as wages. The balance sheet items that distort profit.
Learn moreBehind on payroll taxes
Missed deposits, unfiled quarterly returns, W-2s never issued. The most urgent kind of behind.
Learn morePersonal and business mixed
One pot for everything. Separating business activity from personal, in both directions.
Learn moreUnfiled returns and no books
Returns went unfiled because the numbers were never there. Books first, then every open return.
Learn moreCleanup Planner
Eight questions, then a plan: what comes first, what to gather, and which guides apply.
Part of Messy Books Help, alongside our catch-up bookkeeping service.
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