By Vesela Harris, CPA, EA | JE Tax Advisors LLC
Updated October 19, 2026 | For the 2026 tax year
A bank statement can show that you paid $240 to a restaurant. It usually cannot show who attended, what business was discussed, or whether the meal qualified for a deduction.
That difference matters if the IRS asks questions. Reporting an expense is one step. Being able to explain and support it is another.
For individuals and small business owners, the best preparation is an accurate return backed by organized records. S corporation owners also need to pay attention to shareholder compensation, payroll, distributions, and basis. These issues connect the corporate return with the owner’s personal taxes.
An audit does not automatically mean you did something wrong
The IRS selects returns through several methods, including statistical screening and examinations involving related taxpayers. Being selected does not, by itself, establish that a return contains an error.
No preparer can guarantee that you will never be audited. A large refund or a legitimate deduction does not automatically mean an audit will follow. The objective is to report correctly and support the positions taken.
Also, not every IRS letter is an audit. An income mismatch can generate a CP2000 notice proposing changes. That proposal needs review, but it is different from an examination.
IRS audit selection guidance and IRS explanation of CP2000 notices
1. S corporation salary: do not treat all owner payments as distributions
An S corporation shareholder who works in the business cannot simply label all payments as distributions to avoid employment taxes.
The IRS requires reasonable compensation for the services a shareholder employee provides before nonwage distributions are made in place of that compensation. If payments should have been wages, the IRS can reclassify them, creating additional employment taxes and potentially penalties and interest.
For example, an owner who performs the company’s consulting work, manages clients, and generates most of its revenue has a compensation issue to address when taking distributions with little or no salary. Calling the payments “owner draws” does not resolve it.
This is a compliance concern, not a prediction that a particular salary will cause an audit. The question is whether the treatment of payments can be supported by the work performed and the surrounding facts.
IRS guidance: S corporation reasonable compensation
There is no universal salary percentage
A “60/40 rule” or another fixed split between wages and distributions is not an IRS safe harbor for reasonable compensation. Neither is a salary chosen simply because it produces the lowest payroll tax.
Consider the owner’s duties, experience, time devoted to the business, comparable pay, and how the business earns its revenue. A business relying primarily on the owner’s personal services can present different facts from one relying heavily on employees, equipment, or capital.
Keep a compensation analysis describing the role, hours, wage comparisons, and reasons for the salary selected. Update it when responsibilities or business operations change. A salary study can help document the decision, but its conclusion still needs to fit the facts.
IRS explanation of compensation factors
2. Report income once, completely, and in the right place
Business income does not become tax free because it was paid in cash or because no information form arrived.
Reconcile your books with customer payments, bank deposits, payment processors, and tax forms. Explain differences instead of copying each form into the return and hoping the totals work.
Payment reporting can also overlap. A customer payment already included in sales should not be counted again simply because it appears on an information form. Processor reports may show gross payments before fees or adjustments.
At the same time, not every deposit is sales income. Loan proceeds, transfers between accounts, and owner contributions need the correct treatment and supporting records.
If a form includes a personal reimbursement or another incorrect amount, request a correction and retain the explanation. Do not assume the form is correct or ignore it without reviewing the reporting requirements.
IRS guidance: Payment reporting and business income
3. Keep evidence beyond the credit card statement
A charge appearing on a business card is not enough to establish a business deduction.
Keep invoices, receipts, contracts, and notes that explain the business purpose. Separate personal expenses from business costs and allocate mixed expenses using a supportable method.
A family vacation does not become deductible because you answered client emails during the trip. A personal purchase does not become a business expense because the company paid for it.
If you pay a legitimate corporate expense personally, use the proper accounting and reimbursement process. Under an accountable plan, eligible employee expenses must have a business connection, be substantiated within a reasonable period, and include repayment of excess advances. A flat allowance without support is not automatically tax free.
IRS guidance: Business expenses and accountable reimbursement plans
4. Support vehicle, meal, and travel deductions as you go
For business driving, keep dates, destinations, miles, and business purposes. A mileage total reconstructed from memory at tax time is harder to support than a record maintained throughout the year.
Ordinary commuting generally is not deductible. Using a vehicle occasionally for business does not justify claiming all its costs.
Choose an eligible vehicle expense method and apply it consistently. Generally, the standard mileage deduction already covers items such as gas, repairs, insurance, and depreciation for that use.
For meals, record who attended and the business purpose. Qualifying business meals are generally 50% deductible, subject to exceptions. An ordinary lunch by yourself is not deductible merely because it happened during a workday.
For travel, separate business expenses from personal portions and retain the itinerary and supporting documents.
IRS guidance: Travel, meals, and vehicle expenses
5. Claim a home office only when the space qualifies
A qualifying home office is a legitimate deduction. You do not need to give it up out of fear.
You do need to meet the applicable requirements. Generally, the space must be used regularly and exclusively for business and satisfy a qualifying business use test. Certain inventory and daycare uses have exceptions.
A room used as both an office and a guest bedroom usually does not meet the exclusive use requirement.
Keep measurements, calculations, and expense records. S corporation owners should review the appropriate reimbursement method rather than copy the treatment used by a sole proprietor.
IRS guidance: Business use of your home
6. Track shareholder basis before deducting losses or taking distributions
An S corporation loss shown on a shareholder’s tax information is not automatically deductible on the personal return.
Stock and debt basis limits apply, and other limitations can follow. The shareholder needs records of contributions, distributions, income, losses, and qualifying loans. The corporation’s bank balance or retained earnings does not replace that calculation.
Likewise, distributions are not automatically tax free. Stock basis is important in determining their treatment. A shareholder’s guarantee of corporate debt does not, by itself, create debt basis.
Form 7203 is used to calculate stock and debt basis, and filing requirements apply in specified situations. Review basis annually rather than try to reconstruct several years when a loss or distribution raises questions.
IRS guidance: S corporation stock and debt basis
7. Review payroll, benefits, and worker classification
An expense can be legitimate while its reporting is still wrong.
For example, health insurance for a shareholder owning more than 2% of an S corporation generally requires corporate payment or reimbursement and inclusion in the shareholder’s wage reporting to support the personal deduction, assuming the other requirements are met.
Worker classification needs attention too. A contract calling someone an independent contractor does not settle their federal tax status. Behavioral control, financial control, and the parties’ relationship matter.
Before filing, compare payroll reports with the books and corporate return. Investigate differences in wages, benefits, and payroll liabilities. Catching an omission before the final payroll filings is usually easier than correcting several forms afterward.
IRS health insurance instructions and worker classification guidance
8. Do not claim personal deductions without the required documents
Individuals need supporting records too, especially for charitable contributions.
For a deductible contribution of $250 or more, a bank record alone is not enough. Obtain the required written acknowledgment from the charity within the applicable deadline.
Noncash donations may require Form 8283 and, in some cases, a qualified appraisal. Keep a description of the property, its condition when relevant, and how you determined the value.
A donation receipt does not automatically establish that the full amount is deductible. Verify the organization, any benefits received in return, and the rules for the year of the gift.
IRS guidance: Charitable contribution documentation
9. Keep records for the appropriate period
Three years is a common starting point for income tax records, not a rule that every document can be discarded after three years.
Longer periods can apply. The IRS generally lists six years when omitted income exceeds 25% of reported gross income, and indefinite retention for fraudulent returns or returns never filed.
Employment tax records generally should be kept for at least four years after the tax becomes due or is paid, whichever is later.
Property records may need to be kept through ownership and the applicable period after disposal. Keep records needed to support shareholder basis, carryovers, depreciation, and other amounts affecting future returns.
IRS guidance: How long to keep records
10. Take an IRS notice seriously without assuming it is correct
Read the notice, identify the tax year and issue, and calendar the response deadline. A proposed adjustment can be incorrect or based on incomplete information.
For an audit, the IRS generally makes initial contact by mail. Follow the written request and provide organized records relevant to the issue. If more time is needed, request it promptly rather than assume the deadline is extended.
You have rights, including the right to representation and to challenge the IRS position. A CPA, enrolled agent, or attorney can help evaluate the issue and communicate with the IRS under the appropriate authorization.
Do not change records to fit a requested result. If you discover an error, discuss the correct way to address it.
IRS examination process and Taxpayer Bill of Rights
A practical review before filing your 2026 return
Before approving the return, ask:
- Does the reported income reconcile with my records and tax forms?
- Can I explain and document the deductions?
- Have personal expenses and duplicate entries been removed?
- If I own an S corporation, are compensation, benefits, and distributions handled correctly?
- Are shareholder basis records current?
- Do I understand the significant positions taken on the return?
A professional review should address the facts behind the numbers. Tax software cannot determine whether a shareholder’s salary is reasonable or whether a meal had a business purpose without reliable information.
Tax preparation and IRS representation with JE Tax Advisors
At JE Tax Advisors LLC, I help individuals and business owners with tax preparation, accounting, planning, and IRS representation.
For S corporation clients, that includes reviewing how the business return connects with shareholder compensation, benefits, distributions, and personal taxes.
Based in Auburn, Georgia, I work with clients throughout metro Atlanta and remotely. Contact JE Tax Advisors or call (470) 403 0754 to discuss your return or an IRS notice.
You can also read How Can Small Businesses Save on Taxes? for planning ideas to discuss before year end.
This article addresses federal tax compliance for 2026 under guidance available as of October 19, 2026. Prior tax years and state rules may differ. The appropriate treatment depends on your circumstances.