Running an S-Corporation comes with incredible tax advantages — but only if you follow the rules correctly. As we head toward year-end, it’s essential for S-Corp owners to review a few key areas that the IRS pays close attention to. These rules are simple on the surface, but mistakes can lead to payroll issues, lost deductions, amended returns, or even penalties.
Below is a clear, strategic breakdown of the three most important S-Corp tax rules every owner must understand — and act on — before December 31.
If you own more than 2% of your S-Corp (most small-business owners do) and your S corp pays for health insurance premiums, the IRS requires that the cost of your health insurance be included in your W-2.
This is one of the most commonly missed compliance items, and the consequences can be expensive.
Those premiums must be added to your W-2 as wages (usually not subject to Social Security or Medicare tax).
You may be eligible to claim the Self-Employed Health Insurance Deduction on your personal tax return.
If the insurance isn’t correctly reported:
You may lose the deduction entirely
You risk IRS adjustments during an audit
Payroll filings may need to be amended
This is one of the simplest year-end tasks — but extremely valuable when done right.
The IRS requires all S-Corp owner-employees to take a reasonable salary before taking distributions.
This single rule is one of the biggest IRS audit triggers for S-Corps.
There’s no universal number, but key factors include:
Your role and responsibilities
Time spent working in the business
Industry and location
Comparable employee wages
If you're taking distributions but little (or no) payroll, the IRS sees that as avoiding payroll taxes — and they can reclassify distributions as wages.
Failure to pay a reasonable salary can result in back taxes, penalties, and interest
Your distributions may be reclassified as payroll
You may lose certain deductions tied to payroll
If you haven't run payroll this year — or your salary is unrealistically low — now is the time to fix it.
Many S-Corp owners hire spouses or children to help in the business — which is perfectly fine. But the IRS expects these positions to be legitimate and treated like any other employment relationship.
You must run payroll and withhold taxes
Compensation must be reasonable based on the work performed
Payroll records, job descriptions, and hours worked should be documented
The IRS knows S-Corps often use family employment to shift income — which is why this area gets increased scrutiny.
Paying large sums to family members with no real job duties
Using payroll to shift income into lower tax brackets
Paying minors in ways that don’t match their actual skills or contributions
Done correctly, hiring family can be a smart tax strategy. Done incorrectly, it can create red flags.
Here’s a quick summary to ensure you’re ready before December 31:
S-Corps are among the most tax-efficient business structures, but these benefits rely on strict compliance with IRS rules. Missing one of these steps can:
Reduce deductions
Create audit exposure
Trigger payroll amendments
Lead to costly penalties
The good news? With proactive planning, these issues are entirely avoidable.
KFM specializes in accounting, tax compliance, and year-end planning for small and medium-sized business owners. If you want clarity and confidence heading into tax season, we can help.
📅 Schedule a tax strategy session with KFM
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