S Corp bookkeeping can differ from the usual record-keeping for your average business. Corporations have different structures and follow different rules.
In this post, we’ll talk about the books you need for proper S Corp financial management and taxation. We’ll also go over some tips to stay ahead and out of trouble.
What Sets S Corp Bookkeeping Apart from Other Business Entities
Bookkeeping for S Corps is different mainly because of the way it passes taxes through to owners or shareholders, which prevents double taxation.
In relation to this, here are some things that set it apart from bookkeeping methods for other types of businesses:
- Detailed corporation records: Documents like meeting minutes and by-laws need to be carefully recorded together with financial reports to maintain an S Corp status.
- Passed-through tax forms: S Corps file Form 1120-S together with a Schedule K-1, which reflects each shareholder’s share of the company’s income.
- Shareholder responsibility: Since shareholders pay their own taxes based on how much profit or salaries they receive, they are responsible for keeping their own books and filing on time.
However, because of the complex nature of S Corp businesses, it’s best to provide guidance to every shareholder and keep records within the company to maintain accuracy and ensure all guidelines are met. This is also why bookkeeping is important!
How to Choose the Right Accounting Method: Cash vs. Accrual
Using accrual accounting vs cash accounting is important when dealing with S corp bookkeeping. The main difference between the two boils down to when you record revenue and expenses. Here’s how you judge which method is the right fit for your S corp.
Cash Basis Criteria
Cash basis can simplify bookkeeping in the initial stages of a business. If you are a startup or small business with straightforward transactions and low inventory levels, cash accounting works well. It can also benefit businesses that primarily focus on managing cash flow.
Accrual Basis Criteria
S corporations with a significant amount of credit sales and purchases on account should consider accrual accounting. This method also provides businesses a more comprehensive view of their financial performance as they grow.
If you aim to secure loans or attract investors, accrual basis accounting makes your business more attractive.
Hybrid Cash / Accrual
Some S corps might use a modified approach, using accrual accounting for specific areas like inventory, and cash accounting for others.
S corp bookkeeping can generally be either cash or accrual accounting if annual gross receipts stay under $25 million. The IRS does note exceptions, however, so we recommend consulting a tax advisor to see what the IRS will allow.
Note also that the method you choose can affect your taxes since it influences when you report income and expenses.
Key Bookkeeping Tasks for S Corps
Let’s look at the main tasks your bookkeeper will do for your S Corp business:
Recording Transactions
- Develop a system for collecting and storing receipts, invoices, and other transaction-related documentation.
- Maintain accurate records using a consistent system for categorizing and tracking transactions.
- Track all income, including revenue from sales, interest earned, service fees, and other business income.
- Track all business-related expenses, like rent, utilities, salaries, subscriptions, and supplies.
Managing Financial Records
- Implement internal controls to safeguard financial data.
- Maintain an accurate general ledger of all financial accounts, including assets, liabilities, and equity on top of revenue and expenses.
- Manage accounts payable and receivable, effectively tracking outstanding invoices and payments to maintain healthy cash flow.
- Reconcile bank statements on a schedule to identify and correct discrepancies quickly.
- Prepare income statements, balance sheets, and cash flow statements on a schedule to track financial health.
Ensuring Tax Compliance
- Ensure proper withholding taxes and timely payment of payroll taxes.
- Correctly estimate and pay taxes throughout the year to avoid penalties from the IRS.
- Keep detailed records of all tax-related information, including deductions and payroll taxes.
- Stay updated on changes in tax regulations.
How to Manage Your S Corp Finances
If you believe electing to be an S Corp is the best option for your business, here are ways to manage your revenue and expenses:
Revenue and Expense Management
Below are some strategies for managing and categorizing S corp revenues and expenses to streamline financial operations.
Revenue Management
- Clearly define all the ways your S corporation generates income, like sales of products or services, interest on investments, and royalties.
- Create separate accounts for each revenue source to track and analyze income stream performance more easily.
- Use a customer relationship management (CRM) system to track customer data and sales activity to identify trends and optimize sales efforts.
Expense Management
- Create a standardized chart of accounts to accurately classify expenses like rent, utilities, salaries, marketing, office supplies, and travel.
- Break down broader categories like marketing into subcategories. You can add advertising, social media campaigns, and branding events, for example, for a more granular view of spending patterns.
- Use expense tracking tools to capture receipts electronically, error-proofing data entry and reducing the risk of losing documentation.
- Integrate your business credit card with your accounting software to automatically import transactions, too.
Streamlining Operations
- Regularly reconcile bank statements and credit card statements with S corp bookkeeping records to ensure accuracy and address any discrepancies.
- Use accounting software with features like automatic bank feeds to automate repetitive tasks.
- Consider using cloud-based accounting software to allow real-time remote access and collaboration as well as data backup and security.
- Regularly generate reports to monitor income, expenses, and profitability, and analyze areas for cost reduction or revenue growth.
Asset and Liability Tracking
Below are some tips for effective asset and liability tracking using bookkeeping software.
Asset and Liability Accounts
- Separate fixed assets with a long useful life and current assets readily convertible to cash.
- Separate long-term debt and current liabilities due within a year.
- Describe each asset and liability account in detail to easily identify specific assets and liabilities.
Asset Additions and Disposals
- Maintain detailed documentation for asset purchases to help with depreciation calculations and future disposal.
- Create a depreciation schedule for fixed assets that automatically calculates depreciation expenses over their useful life to ensure accurate statements.
- Record the disposal of assets with complete details on sale price, date, and any gain or loss on disposal.
Liability Management
- Track outstanding bills from vendors and expenses incurred but not yet invoiced.
- Set up separate accounts for each loan and record principal amounts, interest rates, and payment schedules for easy reconciliation.
Common Challenges in Bookkeeping for S Corps
To fully enjoy the benefits of an S Corp status, such as protected personal assets and avoiding double taxation, you need to balance the pros with the cons that come with it.
The following are common bookkeeping challenges that business owners face:
- More stringent bookkeeping process: S Corps follows strict protocols, such as payroll tax rules and formalized by-laws, which call for more detailed and accurate bookkeeping.
- Determining a reasonable salary per shareholder: Owners are entitled to a fair wage paid by the business. However, determining how much a “fair” or “reasonable” salary is can be tricky. Both under and over-paying can result in closer IRS scrutiny and even trigger an audit.
Some things to consider to make sure you’re paying yourself the right amount are:
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- Your role or job description
- The company’s financial performance
- Industry standards
- Capping shareholder distribution: Aside from salaries, owners can receive profits in the form of shareholder distributions. Like with salaries, however, they must not be too large that you exceed agreements with partner banks.
For instance, if you have a bank loan, you need to keep track of the maximum distributions you can receive to meet loan agreements.
- Separating personal and business records: Because of the nature of an S Corp, it can be challenging to keep your personal and business records separate. Mingling the two can result in inaccurate accounting and even create taxation problems.
Why Should You Outsource Bookkeeping for Your S Corp?
S Corps follow more rigorous protocols, which require more detailed, thorough, and accurate bookkeeping. In fact, you would have the same reporting obligations as a single-member LLC.
This means if you’re doing your own bookkeeping, you may have a hard time keeping up. So, should you hire a full-time bookkeeper? You could. But there’s a more cost-effective way: bookkeeping outsourcing.
Why? Let’s zoom in:
- Time-consuming routine work: We’re talking about regular record-keeping, compliance, and reporting. The amount of work will keep you from making time for other aspects of business that need your creativity and expertise. Outsourcing routine yet essential bookkeeping tasks will free up your plate significantly.
- Need for qualified professionals: Handling tax obligations, payroll, and other financial records for an S Corp needs experts who understand how an S Corp’s finances should be managed. Having one in-house is great, but a full-time, in-house bookkeeper can be more expensive than outsourcing to vetted professionals.
- Demands dedicated personnel: To ensure compliance with IRS standards, you can’t afford to make mistakes. It also means you can’t have a bookkeeper wear other hats to cut costs (because it’s more prone to error). Outsourcing can provide you with a dedicated bookkeeper without the hefty expenses you would otherwise incur with an in-house staff.
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We take monthly bookkeeping off your plate and deliver you your financial statements by the 15th or 20th of each month.
You’ll have your Profit and Loss Statement, Balance Sheet, and Cash Flow Statement ready for analysis each month so you and your business partners can make better business decisions.
Interested in learning more? Schedule a call with our CEO, Nathan Hirsch.
And here’s some free resources:
Frequently Asked Questions (FAQs)
We’ve tackled some of the most common doubts about S Corp bookkeeping in this section:
What are the Most Common Bookkeeping Mistakes Made By S Corporations?
S corporations, like many small businesses, can fall prey to the mistake of mixing personal and business finances. They also often fail to keep all receipts and records of income and expenses.
Improperly classifying employees and independent contractors or freelancers is another common mistake. The IRS has specific guidelines for this because it has tax implications. Misclassifying hires can lead to penalties and fines.
S corporation owners who also work for the business are also employees, subject to payroll taxes. Forgetting this means skipping tax withholding and payment, which will be penalized.
S corporations can also fail to follow the specific rules that apply regarding shareholder distributions, leading to more tax issues.
How Frequently Should Financial Audits Be Conducted for S Corporations?
The IRS does not have a mandatory audit frequency for S corporations like it does for publicly traded companies. You might want to conduct an audit based on the following factors, however:
- Significant revenue and complex financial structure.
- Lack of strong internal controls that ensure accurate financial reporting.
- Low tolerance for potential financial risks.
- Lender or investor requirements as a condition for a loan or investment.
- Concerns around potential fraudulent activity.
We recommend that S corps do an audit every three years just to make sure everything is clean. If you are getting into a merger, acquisition, or IPO, you can do an additional audit.
What are the Signs That an S Corporation Should Switch From In-house Financial Management to Bookkeeping Outsourcing?
Switching from in-house bookkeeping to outsourced services can be beneficial when:
- The volume and complexity of financial transactions threatens to overwhelm internal resources.
- You face new accounting challenges from entering new markets, adding product lines, or opening international operations.
- Your inventory needs are growing and need specialized bookkeeping expertise.
- In-house bookkeeping costs can get out of control with business growth, while outsourcing allows you to scale up or down.
How Can S Corporations Minimize Their Tax Liability Through Effective Bookkeeping?
Effective bookkeeping can help minimize your tax liability by maximizing legitimate tax deductions. Just don’t over inflate things like the S corp owner’s salary, or it might get flagged by the IRS.
S corporations can distribute profits as a combination of salary and dividends. Dividends are not subject to payroll taxes. Timely tax return filing and accurate records help you to avoid penalties and interest charges from the IRS.
Proper tracking of depreciable assets allows you to deduct a portion of the asset’s cost over its useful life, reducing taxable income. Proper inventory management practices can also optimize cost of goods sold (COGS), reducing taxable income.
What Steps Should Be Taken If Discrepancies are Found During Financial Statement Preparation?
If you spot discrepancies during financial statement preparation, trace the source and identify where things went wrong. Then, correct the error.
Consider whether the error is significant enough to harm investor or creditor confidence, for example. If it is, you might need to disclose the error and its correction in the footnotes of your financial statements for transparency. Consider consulting with a qualified accountant or auditor.
Make sure you document the entire process of investigation and the corrective actions you took. Take steps to prevent similar discrepancies in the future.
Conclusion
S Corp bookkeeping doesn’t have to be daunting if you understand the basics and use the right system. Better yet, outsource your bookkeeping to a reliable partner to get rid of that headache altogether.
