S Corp Bookkeeping: Chart of Accounts, Officer Pay, Distributions

What do an S corporation's books have to show?

The IRS requires no special bookkeeping system, only records that clearly show income and expenses. The Form 1120-S asks for more than a profit and loss: officer pay, a balance sheet that should agree with the corporation's books, distributions by shareholder and shareholder loans.

A case is not simple when any of these is true:

• The owner was paid through a draw, or not paid wages at all.
• Distributions were coded as expenses, or loans and distributions share one equity account.
• Personal spending ran through the company account.
• The books started when the business was a sole proprietorship or limited liability company and still use an owner's draw and owner's capital account.
• The owner's health insurance never reached the W-2, or the balance sheet does not agree with the bank.

Any of these may need correcting before a preparer can start the return.

Gather before the preparer asks:

• The S election paperwork: Form 2553 and any IRS reply
• Payroll reports for every pay date
• Bank and card statements for the whole year
• Loan notes between the corporation and its shareholders
• The last filed return
• Whether the books are on a cash or accrual basis, because the return follows the method the books use

Which accounts does an S corporation need (chart of accounts)?

Beyond the usual bank, card, expense, equipment, debt, receivable and payable accounts, an S corporation needs six groups that feed the Form 1120-S. Account names are bookkeeping practice, not IRS rules: the IRS publishes no required chart of accounts.

The employer's share of payroll taxes is deducted as taxes, not as wages (Publication 334; Publication 535, last revised 2022), so it stays out of lines 7 and 8. Pay reported elsewhere on the return, such as wages in cost of goods sold or elective 401(k) contributions, stays off those lines too.

Keep owner pay, distributions and loans in three separate places. One shared owner draw account hides which dollars were wages, which were distributions and which must be repaid.

How do I record my officer salary, and where do payroll taxes and Forms 941, 940 and W-2 tie in?

An officer who does more than minor work for an S corporation and is paid, or entitled to be paid, is an employee, and the pay is wages even when the officer is also a shareholder (IRS). If that describes the officer, the pay is recorded through payroll as wages, not through an owner's draw account. The corporation decides who is an officer under the law of its state of incorporation; pay to a working owner who holds no office is generally reported as wages on line 8. The corporation must pay reasonable compensation for those services before it makes non-wage distributions. How much is reasonable is covered in S corporation owner salary.

For each pay date:

1. Gross officer wages go to the officer pay account.
2. Withheld income tax and both shares of Social Security and Medicare sit in payroll liability accounts until deposited. Unemployment tax does too.
3. Each deposit clears the liability and keeps its date and amount.

Deposits fall due before the returns. A monthly depositor deposits by the 15th day of the following month; an employer with a higher lookback tax uses the semiweekly schedule, and a large liability can be due the next business day (Publication 15). Federal unemployment tax has its own deposit rule, covered in running payroll yourself. Withheld tax belongs to the government: a responsible person who willfully fails to pay it over can owe a personal penalty of 100% of the unpaid withheld tax (section 6672; trust fund recovery penalty). A payroll liability that never clears is covered in payroll liabilities that won't clear.

Three filings should tie back to those accounts:

Weekends, holidays and timely-deposit rules can move these dates (Publication 15). An employer the IRS has told in writing to file Form 944 files once a year instead of quarterly Form 941. Recording a payroll run is covered in payroll journal entries. If no payroll was ever run for the owner, see S corporation payroll never run.

How do I record distributions (owner's draw) so they stay out of expenses?

Record a distribution as a reduction of equity, never as an expense. A distribution is a payment to an owner for owning stock, so it must not appear on the profit and loss. "Owner's draw" is a sole proprietor's term. In an S corporation, money to an owner is wages through payroll, a distribution through equity, a loan from the corporation that must be repaid, repayment of the owner's own loan, or reimbursement of business costs the owner paid (S corporation expenses never reimbursed). The return reports nondividend distributions on Schedule K line 16d, and each shareholder's K-1 shows that shareholder's own amount in box 16 with code D. A corporation with accumulated earnings and profits from C corporation years can pay part of a distribution as a dividend, reported on Schedule K line 17c and Form 1099-DIV, not on the K-1; see how S corporations are taxed.

Record each distribution by date, shareholder and amount, in that shareholder's own equity account. A distribution is also no substitute for wages: the IRS can treat payments to a working shareholder as wages when the pay is too low. Line-by-line recording, and why distributions throw off Schedule L, is in recording S corporation distributions.

Why must distributions follow ownership?

An S corporation may have only one class of stock. That generally means every share carries identical rights to distributions and liquidation proceeds, as set by the charter, bylaws, state law and binding agreements (Treasury Regulations 1.1361-1(l)). In practice, each distribution is split in proportion to shares held.

A second class of stock would end the S election, so uneven payments to owners are more than a bookkeeping error. Relief for an inadvertent termination exists, but the IRS must find it inadvertent and the corporation must correct the cause and agree to adjustments (section 1362(f)). When the governing documents give identical rights, a distribution that differs in timing or amount does not by itself create a second class, but it is given tax effect according to the facts. Uneven distributions are a point for professional review before the return.

Where does health insurance for a shareholder-employee go?

Premiums the corporation pays for a shareholder-employee who owns more than 2% of the stock or voting power on any day of the year are treated as wages to that shareholder for income tax withholding, and the books carry them with owner pay, not with employee benefits. Stock owned by a spouse, child, grandchild or parent can count toward that test (section 1372(b)). The common miss is paying them from the company account and never adding them to the owner's W-2.

The IRS says the corporation can deduct the premiums and includes them in W-2 box 1. When they are paid under a plan or system covering all employees or a class of employees, they are not Social Security, Medicare or federal unemployment wages and stay out of W-2 boxes 3 and 5, so keep that split in the payroll records. The Form 1120-S instructions put them on line 7 or 8 (or Form 1125-E). For employees at or below the 2% test, plan contributions go on line 18 as employee benefit programs. Whether the owner can deduct the premiums on a personal return has further conditions: see health insurance for S corporation owners.

How do I record money I lend to the corporation, or take out as a loan?

Record a shareholder's loan to the corporation as a liability, and a loan from the corporation to a shareholder as an asset.

The loans-from-shareholders line on Schedule L should generally reconcile to the K-1 amounts, leaving out debt the shareholder only co-signed or guaranteed.

Put each loan in writing with its amount, date and repayment terms. The Form 7203 instructions treat a loan with a written note separately from open account advances. Whether money counts as a loan or as capital depends on the facts; see shareholder loans to an S corporation.

What do I reconcile each month and each quarter?

Reconcile every bank, card and payroll account each month, and tie payroll totals to Form 941 each quarter. These checks are bookkeeping practice, not IRS rules.

Do I need Schedule L, Schedule M-1, Schedule M-2 and Form 1125-E?

Schedule L is required unless the corporation answers Yes to Schedule B question 11. Form 1125-E is required when total receipts reach $500,000 and officer pay is deducted.

Total receipts count more than sales: gross receipts plus the other income lines and certain Schedule K and Form 8825 income (Form 1125-E instructions). Which reports from the books feed these pages is in books to the business tax return; a balance sheet the software cannot produce is in Schedule L balance sheet on a corporate return.

What do I keep for each shareholder, and who keeps it?

The corporation keeps the ledgers that produce each K-1. The shareholder keeps the basis records.

The Form 7203 instructions say the shareholder is responsible for keeping the information needed to figure stock basis, and that a nondividend distribution above stock basis is reported as a capital gain. See S corporation shareholder basis and distributions in excess of basis. Retention periods: Form 1120-S instructions and IRS recordkeeping.

Example

These examples are illustrative, in US dollars.

A solo consultant

An S corporation has US$180,000 of receipts. The owner is paid US$70,000 through payroll and takes US$50,000 of distributions. The salary and the corporation's payroll taxes are expenses. The distributions go to equity and never touch the profit and loss. If total assets are also under US$250,000, question 11 can be answered Yes and Schedules L and M-1 are not required, but the books still hold the balance sheet. The pay amount is illustrative; reasonable pay depends on the work done.

Two shareholders

Two shareholders own 60 percent and 40 percent. A US$100,000 distribution is recorded as US$60,000 and US$40,000, one entry per shareholder, because the corporation has one class of stock. If only the 60 percent owner were paid the full US$100,000, the payments would not match ownership. Whether that is harmless depends on the governing documents, so it needs professional review before the return.

Receipts over the Form 1125-E line

A corporation has US$520,000 of total receipts and pays its only officer and sole shareholder US$90,000. It also pays US$6,000 of health insurance for that owner. The premiums are added to the owner's W-2 box 1 and count as officer pay. Form 1125-E is required because receipts are over US$500,000, it shows US$96,000, and, with no officer pay deducted elsewhere, that total goes on line 7 of the Form 1120-S. Because receipts are also over US$250,000, Schedule L and a balance sheet that agrees with the books are required too.

Different for you?

• Your first Form 1120-S is coming and the books are mixed: no payroll for you, distributions coded as expenses, personal spending through the company account, or an old sole proprietorship or limited liability company file still in use. Where the books restart, what needs restating and what the preparer needs from you are worth settling with a professional before the return: bookkeeping help for S corporations.
• The owner was never on payroll, or you are unsure the pay is reasonable: see S corporation payroll never run and S corporation owner salary. The books and the Form 1120-S then have to be corrected together, so a professional should look at the earlier months before the return: S corporation bookkeeping help.
• A shareholder is not a US citizen or resident: an S corporation may not have a nonresident alien shareholder, and moving abroad alone is not the test, so ownership and tax status need a professional look before any books are fixed. See how S corporations are taxed and cross-border tax help.
• You are asking whether the S corporation needs a new accounting file: see books after an S corporation election.
• You are choosing software, or asking whether entry-level software handles S corporation payroll: see S corporation bookkeeping software.
• The books are months behind: see S corporation catch-up books and bookkeeping help.
• The corporation paid your personal bills: see S corporation paying personal expenses.
• You own several companies: see books for several companies.
• You want to know what an S corporation bookkeeper and preparer cost: see S corporation accounting cost.