S-corp owner with QBI questions - can I take QBI deduction without proper payroll?

The QBI deduction is one of the trickier parts of S-corp ownership, especially when there are payroll issues. Here's what you need to know: First, QBI doesn't apply to your salary - it only applies to the business profits that pass through to you after salary. If you had $63k in gross income and $10k in business deductions, that leaves $53k. If you take a reasonable salary of $36k, then potentially $17k could qualify for QBI. The issue you're facing is that without having run payroll in 2022, the IRS could potentially recharacterize all your S-corp distributions as salary. This would significantly reduce or eliminate your QBI deduction since QBI only applies to non-wage income. You'll want to discuss with your CPA about potentially filing Form 941 and other payroll forms late, including paying the associated penalties. This might allow you to properly classify a portion of your income as salary and the remainder as business profit eligible for QBI.

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I'm a bookkeeper (not tax advice) but I've seen this issue come up with a few clients. The IRS is pretty strict about S-corps paying reasonable compensation before taking distributions. Without having run payroll in 2022, you could potentially be looking at having ALL of your income reclassified as wages, which would eliminate any QBI deduction. One thing I haven't seen mentioned - make sure your CPA looks at whether you made any quarterly estimated tax payments that could offset some of the employment tax liability. Sometimes business owners make estimated payments thinking they're covering all bases, and those can sometimes be applied to the employment tax portion.

Did anyone mention the W-2/W-3 filing requirements? Those have separate penalties if not filed, and you'll need to deal with those too. Also, most states have their own payroll tax requirements with their own penalties. Fixing federal is only part of the solution.

This is a really complex situation, but you're not alone in making this mistake! I went through something similar with my S-corp in 2021. The key thing to understand is that the IRS expects S-corp owners who work in the business to pay themselves a "reasonable salary" before taking any distributions. Without proper payroll, they could indeed reclassify your entire $53k as wages, which would eliminate your QBI deduction entirely. However, all is not lost. You can still file the required payroll forms (941, 940, W-2s, etc.) late and pay the associated penalties. This allows you to establish a reasonable salary amount and potentially save the remaining income as a distribution eligible for QBI. For your situation with $53k after deductions, if you can justify $36k as reasonable compensation, you'd potentially have $17k that could qualify for the 20% QBI deduction (assuming you meet the income thresholds, which it sounds like you do). The penalties will sting, but they're usually less than the tax savings from properly structuring your income. Make sure your CPA helps you document why your chosen salary amount is reasonable - industry data, comparable positions, hours worked, etc. This documentation becomes crucial if the IRS questions your salary determination later. Also don't forget about state payroll requirements if applicable - those often have separate penalties and filing requirements.