S Corp Deductions: Everything You Need to Know
S corp deductions refer to tax deductions that a shareholder of an S corporation is entitled to. 3 min read
2. S Corporation Taxes
3. S Corporation Tax Reporting
4. How to Cut Tax Burdens
S corp deductions refer to tax deductions that a shareholder of an S corporation is entitled to. An S corp is a corporation that chooses to pass corporate income, losses, credits, and deductions through to its shareholders for tax purposes. As such, the shareholders will be assessed tax based on their individual income tax rates. By forming an S corporation, you will be able to avoid double taxation on corporate income.
What Is an S Corp?
In actuality, an S corporation is not truly a corporation. Instead, it is a limited liability company that has opted for a Subchapter S election. Thus, S corporation is a status in the federal tax law. In order to become an S corp, you need to start an LLC or corporation first and then file for S corp status. The LLC or corporation will be your legal entity, and the S corporation will be your taxable entity. Similar to those in sole proprietorships and partnerships, owners of S corporations are regarded as self-employed.
To become eligible for S corp status, your business must be the following:
- a domestic corporation such as an LLC, which does not have to make a formal election to apply for S corp status
- a corporation with fewer than 100 shareholders
- a corporation with shareholders who are United States citizens, resident aliens, estates, certain kinds of trusts, and certain kinds of tax-exempt entities
- a corporation with only one class of stock
S Corporation Taxes
By gaining S corporation status, business owners can avoid self-employment, Social Security, and Medicare taxes on a certain portion of their business profits. Active shareholders of an S corporation can avoid the Affordable Care Act's 3.8-percent Medicare surtax on business profits.
In addition, if an S corp suffers losses, the losses will usually become tax deductions on the individual tax returns of the shareholders. For instance, if you are a 50-percent shareholder of an S corp that loses $10,000 in a year, you can include a $5,000 deduction in your personal tax return. This deduction may help you save anywhere from hundreds to thousands of dollars on taxes. Another benefit of Subchapter S status is that it provides a safer tax return for you to place tax deductions on. This enables you to claim legitimate deductions more comfortably.
In most situations, an S corporation is not required to pay corporate income tax. When it comes to federal taxes, your S corp is regarded as a pass-through entity, meaning that its income and tax deductions and credits will be passed through to you on a Schedule K-1. The income and expenses of an S corporation are divided according to ownership percentage. They are then reported on the shareholders' personal tax returns.
S Corporation Tax Reporting
An S corporation must file an IRS Form 1120S in order for its shareholders to claim deductions. This form serves to notify the IRS of the fiscal activity of the corporation for the year. The IRS will then compare it with the shareholders' individual returns to ensure accurate reporting.
Also, an S corp must provide a K-1 for every shareholder. This document shows the share of earnings and expenses of each shareholder. It contains a detailed list of earnings and expenses, so that every element will be properly categorized, reported, and taxed for each shareholder. At the end of the document, there are instructions for correctly including each S corp income and expense in individual tax returns. An S corporation does not take into account normal business expenses such as taxes, rent, interests, employee benefits, advertising costs, and depreciation.
How to Cut Tax Burdens
- Rent out your home to your S corp — You can rent out your home to your S corp for a maximum of 14 days per year without the need to report the income.
- Deduct your health insurance premiums.
- Maximize deductions for vehicle expenses — Do not sell your business vehicle, because the tax loss stays with it until it is disposed of.
- Write off your vehicle twice — This tax strategy is known as gift-leaseback.
- Offer Medical Expense Reimbursement Plans — Benefits from these plans are nontaxable to your employees and deductible by your business.
If you need help with S corp deductions, you can post your legal need on Upcounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.