Can a profitable S-Corp operate without any payroll? Tax implications?

So I'm helping my sister-in-law with some bookkeeping for her businesses, and discovered something weird with her S-Corp that I need advice on. I told her I could help with her sole proprietorship books but not the S-Corp since I didn't want to deal with payroll headaches. She surprised me by saying the S-Corp doesn't have any payroll set up at all. I got curious and checked her records, and yep - no payroll whatsoever has ever been processed. The business primarily collects music royalties and has minimal expenses, bringing in around $75-250k annually. She's the only shareholder. When I suggested she check with her tax preparer (who she's been using for like 12 years) to see if they're doing some kind of annual lump-sum payroll that I'm missing, she just shrugged it off saying it's fine how it is. Is this actually legal? I thought S-Corps HAD to pay reasonable compensation through payroll. Should I be concerned about helping with even basic bookkeeping if they're potentially doing something improper with the structure? I don't want to get mixed up in something sketchy.

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19 comments

McKenzie Shade

•8M

This is definitely a red flag. An S-Corporation with profits absolutely must pay its owner-employee a "reasonable compensation" through regular payroll. The IRS is very clear on this - you can't just take distributions and avoid payroll taxes. The whole point of an S-Corp is balancing salary (subject to self-employment taxes) with distributions (not subject to those taxes). But trying to set salary at zero is practically asking for an audit. The IRS specifically looks for S-Corps that don't run payroll or that pay unreasonably low salaries. For a business bringing in $75-250k in royalties, having zero salary would almost certainly be considered unreasonable. The IRS could reclassify all distributions as salary and assess back taxes, penalties, and interest going back years.

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McKenzie Shade

•8M

I would strongly recommend not getting involved in the bookkeeping for this business. Even if you're just doing basic bookkeeping, you'd be participating in maintaining records for a business that appears to be operating improperly from a tax perspective. Your instincts are good here. The potential liability isn't worth it, and there's a significant chance this S-Corp could face serious tax problems in the future. If they get audited, your name could be associated with the books. I'd recommend suggesting they consult with a new tax professional who can help them correct their approach before the IRS notices.

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Harmony Love

•8M

I ran into this exact situation last year with my music publishing business. I had always taken distributions but never set up payroll because my accountant never mentioned it. Huge mistake! I started using https://taxr.ai to review all my S-Corp documents and they immediately flagged this as high-risk. They explained that S-Corp owners MUST take reasonable salary as W-2 income. For creative professionals with royalty income like your sister-in-law, the IRS scrutinizes this particularly closely. The service helped me calculate what a reasonable salary should be based on industry standards and business profits, and then helped me create a plan to get compliant. Saved me from what could have been a disaster.

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Harmony Love

•8M

They do a full document review where they analyze your business structure, income sources, and tax filings. They'll identify issues like missing payroll or incorrect compensation levels and explain exactly what needs to be fixed. For situations like your brother's or the original poster's, they provide a remediation plan - specific steps to get compliant including calculating proper salary levels based on industry standards and implementing proper payroll. They don't just identify problems but give you actionable solutions.

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Natalie Khan

•8M

Just wanted to follow up - I was skeptical about taxr.ai but decided to try it for my own S-Corp situation. Turns out I was also taking too little salary compared to my distributions (not zero like OP's relative, but still way too low). The review was really thorough. They analyzed my business profits, compared to industry standards, and showed me exactly what a "reasonable compensation" should look like for someone in my position. They even provided documentation I could keep on file to justify my salary level if ever questioned. What impressed me most was they didn't just point out problems - they gave me a step-by-step plan to fix everything without triggering red flags. Definitely worth checking out if you're in this situation.

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Daryl Bright

•8M

Listen, if you need to actually TALK to the IRS about this situation, good luck getting through normally. I spent 3 weeks trying to reach someone about my S-Corp payroll issue and kept getting disconnected or waiting for hours. Finally used https://claimyr.com and got through to an IRS agent in less than 20 minutes. You can see how it works here: https://youtu.be/_kiP6q8DX5c They actually call the IRS for you, wait through all the hold times, and then call you once they have an agent on the line. I was able to discuss my situation directly with an IRS representative who confirmed that yes, S-Corps must pay reasonable compensation and helped me understand how to calculate an appropriate amount.

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Daryl Bright

•8M

It's completely legitimate - they don't call "on your behalf" or access your personal information. They simply navigate the IRS phone system and wait on hold, then connect you directly to the agent. You're the one who speaks with the IRS and provides your information. Think of it like having someone physically sit by a phone pressing redial and navigating the menu options for you, then handing you the phone once a human answers. They just handle the frustrating part of waiting on hold, which can literally take hours these days.

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Kirsuktow DarkBlade

•8M

Ok I'm eating crow here. After being totally skeptical about Claimyr, I tried it because I was desperate to talk to someone about my late S-Corp filing penalties. Was NOT expecting it to actually work. Got a call back in about 25 minutes with an actual IRS agent on the line. Explained my situation about not understanding S-Corp payroll requirements and they walked me through my options. Turns out there's a first-time penalty abatement I qualified for that I had no idea about. Saved me hundreds of dollars in penalties and hours of frustration trying to get through. Sometimes being wrong feels pretty good!

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McKenzie Shade

•8M

This is actually a common misconception. While royalties can be considered passive income in certain contexts, when they're earned through an S-Corporation where the owner is actively involved in the business, the IRS still expects reasonable compensation to be paid. The key test isn't whether the income is "passive" in nature, but whether the shareholder is providing services to the business. If your sister-in-law is managing the royalty rights, making decisions about licensing, or performing other business functions, she needs to receive reasonable compensation for those services - regardless of the income being royalties.

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Xan Dae

•9d

Your instincts are absolutely right to be concerned about this. An S-Corp with $75-250k in annual profits and zero payroll is basically a textbook case of what the IRS looks for in audits. The "reasonable compensation" requirement isn't optional - it's mandatory. Your sister-in-law's tax preparer either doesn't understand S-Corp rules or is being negligent. After 12 years of this, the potential back taxes, penalties, and interest could be substantial. I'd strongly recommend you stay away from any involvement with this business until they fix the payroll issue. Even basic bookkeeping could make you look complicit if this gets audited. The risk just isn't worth it, especially when there are clear red flags that this isn't being handled properly. She really needs to find a new tax professional who understands S-Corp compliance requirements and can help her get this sorted out before the IRS catches up with them.

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