Yes, you can borrow money from your S Corporation, but it must be structured as a bona fide loan with a written promissory note, reasonable interest rates (at least the Applicable Federal Rate), and a set repayment schedule. Without proper documentation, the IRS may reclassify the funds as a taxable distribution or compensation, potentially triggering taxes, penalties, and interest.
You can make withdrawals to pay yourself from your business bank account to your personal bank account at any time, as long as you have enough funds left over for your salary and business operations. Tip: Shareholder dividends are different from owner distributions. Dividends apply to C Corporations.
The "2% rule" for S Corporations treats shareholders owning more than 2% of the company's stock (or voting power) differently for fringe benefits, classifying them like partners in a partnership, not regular employees; this means benefits like health insurance premiums paid by the S Corp must be included as taxable wages on their W-2, rather than being tax-free, though the shareholder can often deduct these premiums as an "above-the-line" deduction. This rule prevents them from participating in tax-advantaged Section 125 cafeteria plans, making benefits like Health FSAs unavailable on a pre-tax basis.
S corp income can be passive or non-passive, depending on material participation. Passive income includes rental activities, limited partnerships, and royalties where the taxpayer is not materially involved.
As a result, you can pay yourself once annually. However, note that there may be an obligation to file Form 941 reports (whether you have taxes to report or not) on a quarterly basis, so you should take that into consideration.
An S corporation does have some potential disadvantages.
The IRS uses a combination of automated and human processes to select which tax returns to audit. Not reporting all of your income is an easy-to-avoid red flag that can lead to an audit. Taking excessive business tax deductions and mixing business and personal expenses can lead to an audit.
Loans between S corporations and shareholders must follow IRS guidelines to avoid being reclassified as taxable income or distributions. Formal documentation, including promissory notes with stated interest and repayment terms, is essential to establish the loan's legitimacy.
For S Corp owners, the compensation structure involves a reasonable salary (subject to payroll taxes) plus shareholder distributions (generally not subject to payroll taxes). Generally, shareholder distributions are achieved by transferring funds from your business checking account to your personal bank account.
Who pays more taxes, an LLC or S Corp? Typically, an LLC taxed as a sole proprietorship pays more taxes and S Corp tax status means paying less in taxes. By default, an LLC pays taxes as a sole proprietorship, which includes self-employment tax on your total profits.
S-Corp reasonable salary is the market-rate compensation you must pay yourself before taking distributions, typically ranging from $40,000-$150,000+, depending on your role, industry, and location. The IRS requires this to prevent payroll tax avoidance, with penalties reaching 20% plus interest for non-compliance.
Certain types of corporations cannot elect to be S corporations, including certain financial institutions, insurance companies, and international sales corporations. The corporation must elect to be an S corporation by filing IRS Form 2553.
Some key features of S corporations are: They do not pay federal income taxes. They're limited by the types of owners (shareholders) and cannot exceed 100 shareholders. A separate bank account and separate records are required with this form of business.
A business owner uses company funds to cover personal expenses but records them properly as shareholder distributions or owner draws. These aren't being deducted, so they're not illegal. But they still create problems.
For California purposes, the S corporation's accounting period must be the same as the one used for federal purposes. The first accounting period cannot end more than 12 months after the date of incorporation or qualification in California.
Even if an S Corp has no income, it must file IRS Form 1120S annually to maintain compliance. Filing establishes a tax record, prevents IRS assumptions about tax liability, and avoids penalties. Business expenses can still be deducted, potentially resulting in a loss that carries forward.