Getting the books ready for an S corporation election
An S corporation election needs three things the sole proprietorship never had: business and personal transactions separated on evidence, a payroll running a documented reasonable salary, and an accountable plan for home office and vehicle costs. This is an illustrative example set in a US photographer who has run four years through one bank account.
Scenario — an illustrative example of how Salt approaches this problem. Not a description of a specific client engagement.
The business shape it describes: US photographer, sole proprietor moving to S-corp.
- Scenario covers
- Books cleanup, separation of personal and business transactions, and S-corp readiness support
- Software it assumes
- QuickBooks Online · Gusto · Dext · Stripe
- Jurisdiction
- United States
- Sector
- Creative services
- The photographer has traded as a sole proprietor, reporting on Schedule C, with one bank account and one card used for everything.
- An accountant has recommended electing S corporation status for the self-employment tax saving.
- The election is a form. The books it assumes exist do not.
- Business and personal transactions are fully mixed. Equipment, travel and software sit alongside groceries in one account, and four years of it has to be separated by judgement rather than by rule.
- Home office and vehicle use are being claimed with no contemporaneous record behind them.
- There is no basis on file for the reasonable compensation an S corporation shareholder-employee must be paid before taking distributions.
- The deductions change shape after incorporation. A shareholder-employee does not claim home office and mileage the way a sole proprietor does; the mechanism becomes reimbursement from the corporation under an accountable plan.
- Sales tax on print and product sales has been ignored, and changing entity does not resolve it.
- A business bank account and a business card would be opened first, with every business transaction running through them from that date. This is the change that stops the problem recurring, and it happens before any historic work starts.
- The current year would be separated first, so the corporation opens on a clean ledger, and prior years would then be worked backwards through the period still open to amendment.
- Each historic transaction would be classified business or personal, with anything that cannot be evidenced left out. Reconstructed intent is not a record.
- Home office would be measured as the square footage used regularly and exclusively for business against total home area, and vehicle use would move to a contemporaneous mileage log, which is the only version of that record that stands up.
- A reasonable compensation position would be documented before the first payroll: role, hours, comparable market pay for the work actually performed, and the reasoning written down and dated.
- Payroll would be set up in Gusto, with quarterly Forms 941, state registrations where required, and Forms W-2 by 31 January.
- An accountable plan would be adopted so home office and mileage are reimbursed against substantiation rather than claimed personally or taken as a distribution.
- Form 2553 would be signed and filed by the photographer or the tax preparer. It is due by the 15th day of the third month of the tax year for the election to apply to that year, and the IRS provides late-election relief under Rev. Proc. 2013-30 where the entity intended to be an S corporation from the requested date.
- Four years in a single account means judging, transaction by transaction, what was business and what was not, and leaving out the items that cannot be evidenced rather than claiming them because they probably were.
- The election itself is straightforward. Producing books that stand behind it, and a salary position with something written underneath it, is the actual work.
- Salt prepares the records, runs the payroll and builds the supporting file. The election, the returns and the reasonable compensation conclusion are signed off by the photographer's own tax preparer.
- The photographer would be able to run payroll and take distributions with a written basis for the split between them.
- Home office and vehicle costs would be reimbursed against substantiation rather than claimed against memory.
- The corporation's first year would close on books that were never commingled, which is the part that stays true after the cleanup is finished.
What we'd flag
Some historic deductions will not survive the cleanup, and where there is no record the honest answer is to leave the deduction out, which can make a prior year look worse than it did. An S corporation also carries real running cost — payroll filings, a separate return and a bookkeeping standard that has to be maintained — so the saving has to clear that before the election is worth making.
Getting the books ready for an S corporation election
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