Can My S Corp Pay My Personal Taxes?

Let’s get straight to the point: If you wonder if you can pay your personal taxes out of your S Corp bank account, the answer is a big, fat NO.

Now, before you get all dramatic and jump into a Google search looking for a different, more pleasant answer, let me explain technicalities and hopefully you will make peace with this fact.

In this blog, we will explore why you should not pay your personal taxes out of your S Corp’s bank account, what happens when S Corp owners do it anyway (spoiler alert: they do it a lot), and how to actually go about paying personal taxes the right way without totally screwing up your business finances.

So, why you should not pay for your personal IRS and state taxes out of the S Corps bank account?

The IRS classifies S Corps as pass-through entities, which means they pass all the income and tax responsibilities straight to you, the owner. Do you remember that K-1 form that you get after the S Corp tax return is prepared? Yes, the S Corp’s income and losses flow to your personal return via that K-1 form, which gets entered on your personal tax return. And if you are the one personally liable for this income, why should someone else pay your taxes? The S Corp is still an independent tax entity with its own EIN and bank accounts, and it should not pay for other people’s expenses.This means your personal taxes are, well, are your personal problem. The corporation and your personal finances need to stay separate. Otherwise, besides other unpleasant things, you will break your corporate veil and lose that legal protection everyone is talking about.

What happens if you pay out of your S Corp anyway?

At this point, you might be wondering, "What’s done is done. I’ve already done the wrong thing. But is there a way to fix this before the IRS comes knocking?" The answer is yes—sort of. When you go to your tax accountant (hopefully not in a panic, but let’s be real, that’s usually how it goes), the tax preparer can “fix” the issue. However, we can only do so much. The tax accountant will try to retroactively clean up the mess, but they won't be able to restore the corporate veil once it’s broken.

The first thing we’ll check if your tax payment is showing up as an expense on the S Corp’s books. Booking personal payments as expenses is a classic rookie mistake, and while it might make the business owner happy at first (because their net income looks smaller, which means they think they’ll owe less in taxes), it’s not where these types of payments should go on business financials.

If the tax payments are classified as expenses, the tax accountant will move these tax payments so they don’t appear as an expense on the tax return.

One common method is to treat these payments as an M-1 item on your tax return. In short, in the case of M-1, the tax payment gets disallowed on the return and the memory of this incident gets carried over from year to year on your tax return. This technique is usually used for bigger businesses that are capable of keeping up proper financials and paying for expensive CPA firms. For smaller businesses, tax preparers usually reclassify these types of payments as personal distributions. Personal distributions aren’t tax-deductible, so your taxable income will go up since we’re removing them from expenses. But reclassing these payments to distributions may create a new set of issues:

1. Reasonable Compensation Issue:

   The IRS says: You don’t have to draw a salary in a profitable year as long as you didn’t take any distributions. However, if you did take distributions from your S Corp in a profitable year you must  pay yourself a “reasonable” salary.

   
   

   If you don’t pay yourself a salary but you’re taking distributions, the IRS will say, “Hey, wait a minute, you’re trying to avoid payroll taxes!” And that’s when the trouble starts. In fact, if you don’t take the right salary, the IRS might just reclassify your distributions as wages. Guess what happens when that happens? You’re stuck paying self-employment tax on the money you used to pay for personal taxes. Yikes!

   
   

2. Shareholder Basis Issue:                                                                                             Now, let’s get into something a little more complex: shareholder basis. You can read more about it here. The bottom line is if you take too many distributions and deplete your shareholder basis, those withdrawals for personal taxes could get taxed as capital gains on both federal and state level. Also not good!

   
   

These issues does not arise very happen and in most cases reclassing personal taxes to distribution is the most correct and safe way for the majority of S Corp owners as this reclassification reflects the true state of things.

How to go about paying those personal taxes the right way without totally screwing up your business finances?

Now that we’ve talked about what not to do, let’s figure out how to do things the proper way—going about taxes without ending up in hot water with the IRS. There are a couple of legitimate options.

1. Option 1: Transfer the Money to Your Personal Account and pay your taxes from there. The simplest (and safest) way to pay your personal taxes is to transfer money from your S Corp account to your personal account. This way, you’re not messing with your S Corp’s corporate veil. Once the money is in your personal account, you can pay your personal taxes directly from there.Yes, this technically still counts as a distribution, but at least your CPA won’t have to do any extra work to clean up your books since you have done everything correctly from the start (and won’t be charging you extra for it). Also, if time allows, and you’re feeling extra fancy, you can structure the distribution as a shareholder loan (with interest) and make sure you’re following all the proper documentation and repayment schedules when you take the money out, not a year later when the CPA gets to it.

   
   

2. Option 2: Pay Yourself a Salary and Withhold Taxes from your paycheck. Another option is to pay yourself a salary through your S Corp, and have your payroll provider withhold the appropriate taxes from your paycheck. The S Corp will deduct your wages, and you’ll pay federal and state taxes out of that paycheck. This can get a little complicated because you need to proactively plan for your total tax liability for the whole year. However, it’s a good way to make sure you’re paying your taxes in a timely manner and don’t owe bunch at the tax season. The added bonus? This strategy can help you avoid estimated tax penalties since the IRS treats your tax withholdings as timely payments. We implement this strategy for our tax clients and you can read about it here

   
   

Final Thoughts

In conclusion, the short answer to the question “Can my S Corp pay my personal taxes?” is a resounding no. But like most things in life, just because it’s not allowed doesn’t mean it doesn’t happen. If you’ve made the mistake of using S Corp funds for personal taxes, talk to your tax accountant. A good accountant can help clean things up—though they can’t fix everything. And make sure to keep your business and personal finances separate going forward.

And now, a shameless plug: If you’re dealing with S Corp tax issues (or just want to make sure you’re doing it right from the start), we’ve been doing S Corp taxes for years and know all the ins and outs. Check out our services here and let us help you avoid those pesky tax problems!