By Jessica Irving Marschall, CPA, Marschall Accounting Services, LLC, August 20th, 2026
Every so often, a single week at our office tells a story. This past week, client after client reached out with questions that all circled the same territory: Is my S corporation still the right structure? What changed under the new tax law? How do I pay myself? What happens when I sell, or when a partner leaves?
Recent legislation, a wave of court decisions, and fresh IRS rulings have shifted the ground under small business owners. Here is a plain-English tour of what is new, what has not changed and will be organized around the questions we heard this week.
“Is the S corporation still worth it after the new tax law?”
For most established, profitable businesses, yes, and arguably more than ever. The One Big Beautiful Bill Act (OBBBA) made permanent two provisions S corporation owners had been watching nervously: the 37% top individual income tax rate and the 20% qualified business income (QBI) deduction under Section 199A. For income eligible for the full QBI deduction, that can produce a theoretical effective top federal income tax rate of approximately 29.6%, although the actual benefit depends on taxable income, the type of business, W-2 wages, qualified property, and the other limitations built into Section 199A. The law also temporarily increased the state and local tax (SALT) deduction cap, which is $40,400 for 2026 and particularly relevant to owners in higher-tax states. The increased cap begins phasing down once MAGI exceeds $505,000 in 2026, but it does not disappear immediately at that threshold. Under current law, the higher SALT cap remains temporary and returns to $10,000 beginning in 2030.
The permanence of the tax law is the important feature of the bill. For years, entity-choice planning carried an asterisk because the QBI deduction was scheduled to expire after 2025. That asterisk is gone, which means pass-through structures can be chosen, or kept, with as much confidence as one can have when dealing with Congress and the Internal Revenue Code.
But being an economic realist (some might call it an economic pessimist), I would not confuse greater certainty in the tax code with greater certainty in the economy. With federal debt now around $40 trillion, the government is entering the next recession, financial crisis, war, pandemic, or other national emergency with substantially less fiscal flexibility than we have historically enjoyed. Heavy federal borrowing can also put upward pressure on the cost of capital, which ultimately matters to the same business owners reading this article through mortgages, lines of credit, equipment financing, commercial loans, and the cost of expanding a business. The government can continue to borrow, but interest expense consumes an increasing share of federal resources, and in a true emergency additional borrowing could become considerably more expensive. So while OBBBA gives us a more stable tax framework for long-term entity planning, I would still build flexibility into every business plan but always remember tax certainty does not eliminate economic risk.
There is also no painless way to work our way out of $40 trillion of national debt. From an accounting and economic perspective, there are really only a handful of levers: increase tax revenue, reduce or slow the growth of federal spending, grow the economy faster than the debt, allow inflation to reduce the real value of existing fixed-rate debt, or use some combination of all four. The best-case scenario is not necessarily “paying off” the national debt, but growing GDP and federal revenues fast enough that debt becomes smaller and more manageable relative to the size of the economy. The harder scenarios involve significant spending reductions or higher taxes, both of which ultimately reach households and businesses. Inflation can also reduce the real burden of existing debt, but that is hardly free: taxpayers experience it through reduced purchasing power, higher interest rates, and increased operating and borrowing costs. And simply borrowing to cover ever-growing interest expense compounds the problem rather than solving it. For business owners, that is why the national debt is not just a Washington statistic. Eventually, fiscal choices show up somewhere in taxes, government spending, inflation, interest rates, or economic growth.
Back to the decision on S vs C Corp, the calculus is not one-size-fits-all. For startups planning to raise venture capital or aiming for a major exit, OBBBA also strengthened the case for C corporations by substantially expanding the qualified small business stock (QSBS) rules under Section 1202. For qualifying stock acquired after July 4, 2025, the per-issuer dollar exclusion increased from $10 million to $15 million, the corporate gross-asset ceiling increased from $50 million to $75 million, and a new tiered holding-period schedule allows a 50% exclusion after three years, 75% after four years, and 100% after five years. The alternative exclusion based on 10 times the taxpayer’s adjusted basis remains available. These enhanced rules do not simply convert previously issued QSBS into the new regime, so the stock’s issuance date matters. A bootstrapped services firm and a venture-track startup may now sensibly land on opposite answers. We have many articles and videos covering these types of corporations and the planning that should occur from formation through an eventual exit.
“When does it make sense to switch from a sole proprietorship or LLC to an S corp?”
This remains the most common question we get from newer business owners, and the answer still usually comes down to employment taxes. A sole proprietor, including the owner of a single-member LLC taxed as a disregarded entity, generally pays self-employment tax on net earnings from the business. An S corporation shareholder-employee instead receives reasonable W-2 compensation subject to employment taxes, while S corporation distributions generally are not subject to self-employment tax. That distinction can create meaningful savings, but only when there is enough profit remaining after paying reasonable compensation to justify the additional administrative and compliance costs.
In practice, we often begin modeling an S corporation once a business is consistently producing roughly $60,000 to $80,000 or more of net profit, but there is no universal IRS break-even point. The answer depends heavily on reasonable compensation, state taxes, payroll and tax-preparation costs, retirement planning, the Section 199A deduction, and the owner’s particular circumstances. Below a certain level of profitability, payroll processing, quarterly filings, W-2 reporting, unemployment taxes, and a separate Form 1120-S can consume much of the potential tax savings. At higher profit levels, the savings can become significant. For example, a business producing $100,000 of profit with a defensible $60,000 shareholder salary might generate several thousand dollars of annual employment-tax savings before considering payroll costs and the other tax interactions.
Two cautions. First, “reasonable compensation” is not a suggestion but a requirement, yet the Internal Revenue Code does not provide a table or mechanical formula that produces the correct salary. The IRS looks at factors including the shareholder’s duties, training and experience, time devoted to the business, comparable compensation within the industry, and the overall facts and circumstances. Common sense matters too. Passing through $2 million of business income while paying the full-time CEO-shareholder a $25,000 salary should immediately raise questions. Second, liability protection comes from the underlying legal entity, typically an LLC or corporation, and not from the S corporation tax election itself. A sole proprietorship provides no separate legal liability shield merely because the business is profitable.
There are also several S corporation quirks that business owners frequently discover only after making the election. Health insurance is one of them. A greater-than-2% shareholder generally cannot be treated like a regular employee for fringe-benefit purposes, and the mechanics matter. To preserve the self-employed health insurance deduction, the S corporation generally must pay or reimburse the premiums and properly include them in the shareholder’s Form W-2, with the shareholder then claiming the deduction on the individual return when the requirements are satisfied. I cover this in more detail in my article, Health Insurance Premiums for S Corporation >2% Shareholders. And an S corporation election that makes sense for your operating business does not mean it makes sense for every entity you own. Appreciating real estate is the classic example. Distributing appreciated property from an S corporation generally causes the corporation to recognize gain as though the property had been sold at fair market value, while partnership-taxed LLCs generally provide considerably greater flexibility for real estate ownership, contributions, distributions, and basis planning. I discuss that issue in An Argument Against Holding Real Estate in an S Corporation. Entity choice should be based on what the business actually owns and does, not simply on potential payroll-tax savings.
Basis is another area where S corporation owners can get into trouble. Having cash in the corporate bank account does not necessarily mean a shareholder can take that cash out tax-free. Distributions generally reduce stock basis, and a nondividend distribution exceeding the shareholder’s stock basis can produce taxable capital gain. Losses present a related problem: receiving a loss on Schedule K-1 does not automatically mean the shareholder can deduct it. The shareholder must first have sufficient stock basis or qualifying debt basis, and even then the deduction may be limited further by the at-risk rules, passive activity rules, and other individual-level limitations. Importantly, merely guaranteeing an S corporation’s bank debt generally does not create shareholder debt basis. Unlike partnership liabilities, which can increase a partner’s outside basis under the partnership rules, an S corporation shareholder generally needs actual basis in stock or bona fide indebtedness of the corporation that runs directly to the shareholder. This is why shareholder basis should be maintained contemporaneously rather than reconstructed several years later when the business has a large distribution, loss, or sale.
Then there is the Accumulated Adjustments Account, or AAA, which is frequently confused with shareholder basis. AAA is a corporate-level tax account that generally tracks accumulated S corporation income and losses for purposes of the S corporation distribution rules. It is not cash, retained earnings, or an individual shareholder’s stock basis, and those numbers should not be used interchangeably. For example, assume an S corporation has $300,000 in the bank and $200,000 of AAA, while a shareholder has only $50,000 of stock basis. The existence of $300,000 of cash or $200,000 of AAA does not mean that shareholder can automatically withdraw $200,000 tax-free. The shareholder’s basis still matters, and a nondividend distribution exceeding stock basis can produce taxable gain.
AAA becomes particularly important when an S corporation has accumulated earnings and profits from prior C corporation years. In that situation, the statutory distribution-ordering rules can cause portions of distributions to come from AAA, accumulated C corporation earnings and profits, and other sources, with very different tax consequences. A distribution attributable to accumulated C corporation earnings and profits can be taxable as a dividend, while other portions may reduce basis or ultimately generate gain. Elections can also affect the ordering rules in appropriate circumstances. This is one reason converting an existing C corporation to an S corporation requires considerably more planning than simply filing Form 2553. In short, cash, book retained earnings, AAA, accumulated C corporation earnings and profits, and shareholder basis are separate concepts, even though business owners understandably tend to think of them as one bucket.
There is also a tradeoff to driving shareholder compensation as low as reasonably possible. Retirement-plan contributions for an S corporation shareholder-employee are generally based on W-2 compensation, not shareholder distributions. So, while reducing salary may reduce employment taxes, it can also reduce the compensation available to support retirement-plan contributions. Reasonable compensation planning therefore should not occur in a vacuum. We look at payroll taxes, retirement goals, Section 199A, benefits, and the shareholder’s overall tax situation together rather than simply asking, “What is the lowest salary I can defend?”
“I’m a ‘limited partner.’ Why is the IRS after my self-employment tax?”
Several clients with partnership interests asked about this, and it is one of the most active areas in tax right now. In Soroban Capital Partners (T.C. Memo. 2025-52), the Tax Court continued applying a functional analysis to determine whether partners actually qualify for the “limited partner” exception under Section 1402(a)(13). The court looked beyond labels and examined what the partners actually did for the business, including management responsibilities, investment activities, operational involvement, and the relationship between their services, capital contributions, and distributive shares.
Then the Fifth Circuit went the other direction in Sirius Solutions, rejecting the Tax Court’s functional approach and concluding that a partner in a state-law limited partnership who possesses limited liability can qualify as a “limited partner” for purposes of the Section 1402(a)(13) exception. That decision is particularly important for taxpayers whose cases are appealable to the Fifth Circuit, which covers Texas, Louisiana, and Mississippi. Taxpayers elsewhere may still face the Tax Court’s functional approach unless and until their controlling appellate court, Congress, or ultimately the Supreme Court resolves the issue.
This creates a genuine planning issue in which jurisdiction, legal structure, and the partner’s actual role can all matter. If you are an active manager holding a “limited partner” interest, do not assume that the title alone resolves your self-employment tax treatment. Likewise, do not assume that the Fifth Circuit’s decision automatically governs a taxpayer located elsewhere. Make sure the legal structure matches the intended tax treatment and document the partner’s rights, responsibilities, capital investment, and services.
This split also feeds directly back into entity choice. S corporation shareholder-employees must receive reasonable compensation subject to employment taxes, while the treatment of partnership distributive income under Section 1402 can depend on the type of partnership interest and, following these decisions, potentially the jurisdiction in which the issue is litigated. It is a genuine planning consideration, but one that now demands particularly careful and well-documented positioning.
“We missed an election deadline. Are we stuck?”
Happily, often not. The IRS provides relief for a number of late elections when the applicable requirements are satisfied and the taxpayer acted reasonably and in good faith. Rev. Proc. 2013-30 provides a streamlined procedure for certain late S corporation, QSub, ESBT, and QSST elections, generally available when the requested effective date is not more than three years and 75 days before the relief request, with additional relief available in certain S corporation situations. Recent private letter rulings also illustrate circumstances in which the IRS has granted extensions for other missed elections, including QTIP, Section 754, Section 336(e), and QSub elections, although private letter rulings are directed to particular taxpayers and cannot be relied upon as precedent by other taxpayers. The practical lesson is simple: act promptly once a missed election is discovered and be prepared to establish reasonable cause and good faith where required. If you have just realized an election was never filed, call your CPA before you panic.
“What happens to my S corp when a shareholder dies, divorces, or wants out?”
This week reminded us how few S corporations have a meaningful buy-sell agreement and how dangerous that can be. An S corporation operates under unusually strict eligibility rules: generally no more than 100 shareholders, only permitted types of shareholders, and only one class of stock. The one-class-of-stock rule is also why shareholder agreements, disproportionate distributions, redemption arrangements, and other agreements affecting shareholders’ economic rights should be reviewed carefully rather than treated as ordinary corporate housekeeping. Death, divorce, bankruptcy, or other ownership transitions can create S-election problems if shares ultimately pass to an ineligible shareholder or if an otherwise eligible trust fails to make a required election. An estate can hold S corporation stock, so death itself does not terminate the S election, but post-death administration, subsequent distributions, and trust planning require careful attention.
A well-drafted buy-sell agreement addresses these risks before they become emergencies. It can restrict or prohibit transfers that could jeopardize the S election, establish procedures for death, disability, divorce, retirement, and deadlock, set valuation mechanisms in advance, create purchase rights or obligations, and provide indemnification when a shareholder’s actions damage the corporation or the other shareholders. Recent disputes also reinforce an important point: ownership and its associated tax consequences do not necessarily disappear because business or personal relationships deteriorate. A shareholder may continue to be allocated K-1 income while ownership, management rights, divorce, or bankruptcy issues are being litigated. If your S corporation has more than one shareholder and no carefully drafted buy-sell agreement, this is a good time to fix that.
“I’m thinking about selling my S corporation. Stock sale or asset sale?”
The structure of a sale can dramatically change the seller’s after-tax proceeds and the economics for the buyer. Sellers generally prefer stock sales because gain is often capital in character and the buyer acquires the corporate entity with its existing assets and liabilities, subject to negotiated indemnities, escrows, representations, warranties, and other deal protections. Buyers generally prefer asset acquisitions because the acquired assets receive a new tax basis based on the purchase price, potentially generating future depreciation and amortization deductions while allowing the buyer greater control over which assets and liabilities are assumed. On a multimillion-dollar transaction, the difference in after-tax proceeds between competing structures can easily reach six or seven figures depending on basis, depreciation recapture, goodwill, state taxes, purchase-price allocation, and the corporation’s tax history.
Between a straightforward stock sale and asset sale are planning tools such as a Section 338(h)(10) election, a Section 336(e) election, and certain pre-closing F reorganizations. Depending on the transaction, these structures can provide the buyer with asset-basis benefits while allowing the parties to negotiate how the additional tax cost to the seller is reflected in the purchase price. In an applicable asset acquisition, purchase-price allocation and Form 8594 reporting can therefore become genuine economic negotiation points rather than merely compliance exercises. The unifying theme is simple: model the alternatives before signing the letter of intent, not after. Once the economics and structure are embedded in the deal documents, some of the best tax-planning opportunities may already be gone.
The bottom line
The through-line in this week’s questions is that entity choice and S corporation housekeeping are no longer set-it-and-forget-it decisions. The law just moved, the courts are actively redrawing lines on self-employment tax, and the IRS is granting grace, but only to those who ask properly. If any of these questions sound like yours, we would be glad to walk through the numbers with you.
Jessica Irving Marschall, CPA, is President of Marschall Accounting Services, LLC. This article is for general information only and is not tax, legal, or financial advice for your specific situation. Please consult your advisor before acting.
Sources: The Tax Adviser, “Current Developments in S Corporations” (July 2026); The Tax Adviser, “Buy-Sell Agreements for S Corporations” (Dec. 2025); The Tax Adviser, “Late-Election Relief in Recent IRS Letter Rulings” (Nov. 2025); The Tax Adviser, “Startups and the OBBBA: Rethinking C Corporation vs. Passthrough” (May 2026); The Tax Adviser, “Tax Court Applies Limited Partner Functional Test” (Nov. 2025); Wolters Kluwer, “Compare Types of Partnerships”; JD Supra, “Tax Strategies: Selling Your S Corporation”; Leading Tax Group and SD&O CPA entity-comparison guides.
