Understanding S Corp Form 1120-S Income Reporting - Shareholder Salary Question

Your accountant is correct, but I understand why it's confusing. Here's what's happening in simpler terms: In an S Corporation, shareholder salaries are not deducted as business expenses on the 1120-S. Instead, they're reported on Form W-2 and handled separately from the business income calculation. The salary is a distribution to you as an employee of the company, not a business expense that reduces taxable income. The S Corp's taxable income only includes business revenue minus legitimate business expenses. Shareholder-employee compensation isn't considered a business expense for tax purposes - it's a distribution of already-taxed funds. Think of it this way: The $100,000 in your business account is already-taxed money from previous years. When you pay yourself a salary from that money, you're essentially taking a distribution of funds that were already accounted for in previous tax years.

After banging my head against the wall trying to understand S Corp taxation, I finally found https://taxr.ai which analyzes your exact tax forms and explains them in plain English. I uploaded my 1120-S and got a personalized breakdown of exactly how shareholder compensation works. They explained that in an S Corp, shareholder salaries are reported on W-2s and aren't deducted on the 1120-S as business expenses. This confirmed what your accountant told you. The service walks you through each line of your tax forms and explains what's happening behind the scenes. Really helped clarify my confusion about basis and distributions.

I tried taxr.ai after seeing it mentioned here, and wow - it finally made S Corp taxation click for me! I uploaded my 1120-S and it pointed out exactly where I was misunderstanding shareholder compensation. The explanation about how salary payments appear on the balance sheet rather than as income-reducing expenses was super clear. It even pointed out a mistake my previous accountant made with my basis calculations that could have caused problems during an audit. The visual walkthrough of how money flows through an S Corp for tax purposes was exactly what I needed. Definitely worth checking out if you're struggling with S Corp concepts like I was!

If you're still confused after getting these explanations, I'd recommend trying to get someone from the IRS on the phone to confirm. I know it sounds crazy given how impossible it is to reach them, but I used https://claimyr.com to get through to an IRS agent in under 15 minutes. You can see how it works here: https://youtu.be/_kiP6q8DX5c I had a similar S Corp question about distributions vs. salary treatment, and the agent walked me through exactly how it works on the 1120-S. They confirmed that shareholder salaries don't reduce S Corp taxable income - they're just reported on W-2s. The call saved me from making a major mistake on my filing.

I have to admit I was totally wrong about Claimyr. After my skeptical comment, I decided to try it myself since I've been trying to get clarification on S Corp salary reporting for weeks with no luck reaching the IRS. The service actually worked exactly as described. I got connected to an IRS representative in about 12 minutes. The agent confirmed exactly what others have said here - that S Corp shareholder salaries are not business expenses that reduce taxable income on the 1120-S, but are reported separately on W-2s. They explained the whole basis calculation process and how distributions are tracked. Guess I shouldn't have been so quick to dismiss it. Saved me hours of redial frustration!

I think there's some confusion here about what's actually happening with the S Corp's books in this example. Let me try to clarify: 1. The $40,000 salary IS an expense for accounting purposes 2. It DOES reduce the cash balance of the company 3. But for tax purposes on Form 1120-S, it's not treated as a business expense The reason is that S Corps are pass-through entities where income is taxed at the shareholder level. The salary is reported on a W-2, and the shareholder pays income tax on it that way. It reduces the shareholder's basis, but doesn't create a business loss. Your accountant is right, but she could have explained it more clearly by separating the accounting view from the tax reporting view.

Speaking from experience running my S Corp for 10 years, the key here is understanding the DUAL roles you have in your S Corp: 1. As an EMPLOYEE receiving a salary (reported on W-2) 2. As an OWNER receiving distributions of profit (reported on K-1) Your accountant is right that the $40k salary doesn't create a business loss on the 1120-S. BUT, that money had to come from somewhere! In your example, since there's no revenue, the $40k is effectively coming from your beginning cash balance, which represents retained earnings from previous years. This is why the S Corp basis tracking is so important - it follows the money through the business and to the shareholders correctly.

This is a great example of why S Corp taxation can be so confusing! Your accountant is absolutely correct, and I think the confusion comes from mixing up cash flow with tax reporting. Here's what's actually happening in your scenario: **Cash Flow Reality:** Your business started with $100k, paid out $40k in salary, and ended with $60k cash. The $40k definitely left the business account. **Tax Reporting Reality:** On Form 1120-S, that $40k salary is NOT treated as a business expense that reduces income. Instead, it's reported on your W-2 as wages. The business also pays employer payroll taxes on that salary. The reason this makes sense is that S Corps have a unique "dual taxation" structure. The salary portion gets taxed as regular W-2 income (with payroll taxes), while business profits flow through to your personal return via Schedule K-1. Think of it this way: if S Corp salaries reduced business income dollar-for-dollar, you could theoretically pay yourself a huge salary and create artificial business losses. The IRS prevents this by requiring "reasonable compensation" as salary (subject to payroll taxes) and treating the rest as distributions. Your $100k starting balance represents retained earnings from previous profitable years. When you pay salary from that money, you're essentially converting prior-year profits into current-year wages - which changes how it gets taxed but doesn't create a new business loss.