S Corp Expenses: Everything You Need to Know
One type of limited liability company that can be beneficial to many small businesses is an S corporation or Subchapter S corporation (S corp). 3 min read
2. S Corporation Deductions
3. S Corporation Expenses and Reimbursements
4. Advantages and Disadvantages
Updated July 8, 2020:
One type of limited liability company that can be beneficial to many small businesses is an S corporation or Subchapter S corporation (S corp). Small businesses and companies elect or choose to be classified as an S corp after they have been incorporated. The election allows the business to act as a separate entity while protecting the owners from certain financial and legal liabilities. It also lets the owners avoid having to pay corporate-level taxes.
Classified by the IRS as limited liability corporations (LLCs), S corps are limited to:
- 100 shareholders or owners
- Special estates and trusts.
Like LLCs, S corps are “pass-through” entities, or businesses whose profits, expenses and losses, deductions, and credits go to the owners, who then report that information on their personal income tax returns.
Reporting S Corporation Profits and Losses
Although S corporations do not personally pay taxes because the tax responsibility is passed on to the owners, each S corp is required to file Form 1120S with the IRS. Form 1120S, or an Income Tax Return for an S Corp, gives the IRS details on the S corporation's financial activities to compare with the individual shareholders' returns.
Each shareholder reports the S corps income and expenses based on his or her percentage of ownership on individual returns via form Schedule K-1. For owners, S corp profits are divided into two categories:
- Shareholder wages — a wage paid to owners that is subject to a 15.3 percent tax.
- Distributive share — a division of income, loss, deduction, or credit from the S corp to the owners or partners, based on each shareholder's percentage of ownership. It is not subject to tax
S Corporation Deductions
Typically, S corporation deductions are “ordinary and necessary” business expenses incurred by the S corp that reduce the taxable income. These expenses can include:
- Business losses
- Employee benefits.
They must be claimed on the S corporations Form 1120S, as well as the owners' individual returns and K-1 forms.
Other deductions, which can save your business hundreds of dollars, include:
- Using your home as an office or renting your home to your S corporation.
- Health insurance.
- Business vehicle expense deductions.
- Avoiding Medicare taxes.
- Medical Expense Reimbursement Plans or MERPS.
S Corporation Expenses and Reimbursements
Expenses are those costs the S corporation incurs during the course of its business activities. In addition to the deductions discussed above, which are reimbursable expenses, there are some expenses that are not reimbursable or deductible. These may include:
- The use of a personal vehicle for business activities
- Parking and tolls
- Meals and entertainment
- Other out-of-pocket expenses.
The owners being reimbursed under an accountable plan receive the greatest tax savings because the payments are usually tax-free. The S corporation also benefits because it can deduct the amount of the reimbursement from the business income.
Advantages and Disadvantages
Many of the benefits of an S corporations are tax-related. This can help owners reduce their tax burden and avoid double taxation To benefit from the many advantages and tax breaks, S corp owners need to know:
- How to report S corp finances on their returns
- How taxes are determined
- What business expenses are deductible or reimbursable
- Other deductions or credits available.
The three primary disadvantages to an S corporation are:
- S corporations being subject to the same filing requirements as standard corporations. They must regularly file various business, government, and tax forms as well as financial documents.
- Keeping S corporation and personal expenses separate and well-documented, which requires ample time, effort, and money.
- Being in a state that does not acknowledge S corporations, and thus losing the tax benefits, or being in a state that significantly limits the tax breaks available.
Comprehensive research and accurate bookkeeping are useful in keeping track of expenses, losses, and profits, ensuring reimbursement will be easier to manage. Proper accounting practices assist in avoiding mixing up personal and business finances, which can cause you to miss deductions and credits or having some of those benefits discounted by the IRS. An "Employee Expense Report" form, which breaks down all employee-related expenses, can be useful your S corp in keeping everything organized.
If you need help with S Corporation expenses, you can post your legal need or job 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.