6 common S corporation election mistakes your clients should avoid

6 common S corp election mistakes to avoid

February 19, 2026 1:26 PM

If you have business clients considering changing their LLCs or C corporations from their entity's default tax treatment to S corporation election, now is a great time to remind them about the pitfalls to avoid when making that transition.

Here, some common mistakes entrepreneurs make when switching to S corporation tax treatment and how your clients can avoid them.

1. Missing their filing deadline

S Corp, C corp, LLC and other entity types

Your clients might not realize the federal government won't grant S corporation election at just any time. Help them avoid a delay in getting S corporation tax advantages by informing them of the deadlines for submitting their Form 2553.

To get S corporation tax treatment for tax year 2026:

Existing LLCs and C corporations with a calendar tax year (i.e., Jan. 1 to Dec. 31) must file Form 2553 by March 16, 2026.
Existing LLCs and C corporations that follow a different fiscal year have until two months and 15 days after the start of their fiscal year to file Form 2553.
New LLCs or C corporations have two months and 15 days from their date of formation or incorporation to file for S corporation tax treatment.

If they miss their deadline, their S corporation election will be effective the following tax year unless they requested and are granted relief for a late election.

2. Neglecting to check their entity’s eligibility

Educate your clients about the S corporation eligibility restrictions so they do not waste time, energy and money on filing for the election if their company doesn't meet the IRS's qualification criteria:

Be a domestic corporation (or other entity eligible to be treated as a corporation);
Have only allowable shareholders (individuals, certain trusts and estates); partnerships, corporations and nonresident alien shareholders are not permitted;
Have no more than 100 shareholders;
Have only one class of stock;
Cannot be an ineligible corporation, such as certain financial institutions, insurance companies, and current or former domestic international sales corporations;
Have a tax year ending on Dec. 31 or meet the qualifications (or obtain approvals) for using a different fiscal year.

3. Failing to set up payroll

Business owners who are hands on in the business's operations must take the necessary steps to set up payroll to pay themselves and other owner-employees actively working in the business.

Inform your clients about the various payroll tax accounts they'll need to establish, as well as the withholdings reports and remittance schedules they'll need to follow, and make them aware they must abide by employment laws at the federal, state and local levels.

Naturally, this can create a learning curve for business owners who are accustomed to taking owner's draws from the company's bank account, so you will likely need to guide them through the process or direct them to another resource who can address their needs.

4. Ignoring the reasonable compensation rule

This is a slippery slope for business owners. Sure, who doesn't want to minimize their tax burden? But warn your clients against attempting to game the system. If clients take an unreasonably low salary and compensate themselves with disproportionately high distributions to lessen their Social Security and Medicare tax obligations, they will put themselves at great risk. Failure to pay reasonable compensation may lead to IRS penalties and reclassification of distributions as wages, with back taxes owed.

The IRS requires S corporation shareholder-employees to pay themselves a "reasonable salary" for the work they perform. Reasonable compensation is based on industry standards, job duties, experience, and comparable wages for similar work. For example, suppose a similar position in your client's field earns $80,000 annually, but your client decides to pay themselves only $20,000 while taking the remainder of the company profits as distributions. The IRS would likely become suspicious.

While no exact formula exists for determining reasonable compensation, many accountants recommend allocating 40% to 60% of net income to salary. However, emphasize to your clients that the actual figure they decide on should be supported by data.

5. Not knowing about the 2% rule

Whereas employees in C corporations may receive fringe benefits tax-free, this is not the case for S corporation shareholders who own more than 2% of their company. Benefits such as health insurance premiums must be reported as taxable wages on those shareholders' W-2 forms. This rule is designed to prevent small groups of owners from avoiding payroll taxes through untaxed benefits. The 2% rule helps prevent S corporation owners from avoiding payroll taxes via untaxed benefits.

6. Not checking to see if the state requires an S corporation election filing

Your clients shouldn't assume that their S corporation election at the federal level will automatically give them similar pass-through tax treatment at the state level. While most states recognize the federal S corporation election and automatically apply it, some do not acknowledge it or require additional steps or filings to honor it in their jurisdiction.

States requiring a state-level S corporation or other filing

New Jersey entities authorized to conduct business prior to Dec. 22, 2022, must file an SCORP application to be treated as an S corporation for N.J. tax purposes. Entities authorized to conduct business on or after Dec. 22, 2022, must show proof of their federal S corporation status and submit a Shareholder Jurisdictional Consent form.
New York entities (except in New York City) must file Form CT-6 to allow individual shareholders to report corporate income on their individual state tax returns.
As of Jan. 1, 2026, Louisiana accepts the federal election and does not subject S corporations to franchise tax. (Prior to Jan. 1, 2026, Louisiana S corporations were subject to franchise tax. Also, all shareholders who were Louisiana residents were required to exclude their portion of income and expenses on the corporate tax return and include them on their Louisiana individual income tax returns. In addition, nonresident shareholders had the option of electing to file individual nonresident and part-year resident Louisiana tax returns for their portion of the income and expenses or have the corporation pay the taxes at the corporate income tax rate for their portion of the income.)
Georgia accepts the federal S corporation election, but nonresident shareholders must file Form 600S-CA to acknowledge their agreement to pay Georgia income tax on their proportionate part of the corporation's taxable income.
Mississippi requires Form 84‑380 to confirm nonresident shareholders' agreement to pay Mississippi taxes on their proportionate part of the corporation's taxable income.

Jurisdictions that don't provide pass-through tax treatment to S corporations

New York City
District of Columbia
New Hampshire
Tennessee
Texas

Time is of the essence

As this year's S corporation election deadline approaches for newly formed business entities, now is the time to educate your clients so they have the information they need to avoid common mistakes and oversights. Your expertise and guidance can help them navigate past the hazardous bumps in the road and lead them on a smooth journey as they start and grow their businesses.