S Corp Tax Planning: Everything You Need to Know
S Corp tax planning is important, as you will want to be aware of all of the requirements when it comes to filing S Corp taxes. 3 min read
2. Retroactive Election
3. Owner Salary
4. Other Benefits of an S Corp
S Corp Tax Planning
S Corp tax planning is important, as you will want to be aware of all of the requirements when it comes to filing S Corp taxes. With that said, the S Corp isn’t taxed at the corporate level, but rather operates as a flow-through entity in which all earnings from the S Corp are taxed at the shareholder level on their 1040 tax returns.
It is important to note that even Limited Liability Companies (LLCs) can elect to be taxed as an S Corp while remaining an LLC for business purposes. Generally speaking, the S Corp is a favorable choice for small business owners, as there are certain eligibility requirements that must be met before a business can operate as an S Corp.
If you choose to make a retroactive election to become an S Corp, you can do so by filing IRS Form 2553. Therefore, even if it’s mid-year, you can still file this form to have your business taxed as an S Corp the following tax season. Usually, there is a 75-day rule, requiring businesses to elect to be taxed as an S Corp within 75 days after the prior tax year has ended, i.e., March 15. However, if you choose to make a retroactive election, you can do so by requesting that your business be taxed as an S Corp for that same year. Although, this isn’t always approved, and you might need to wait to be taxed in this manner for the following tax year.
Profits of a sole proprietorship, partnership, and LLC are subject to two taxes – income tax and self-employment tax. However, this isn’t the case with S Corps, as the residual profits aren’t subject to self-employment tax.
Even though this provides a tax benefit to S Corps, such shareholder/employees must pay themselves a reasonable salary for work that is conducted for the business. This salary is, in fact, subject to employment taxes, i.e., Social Security and Medicare. Therefore, only the additional profits leftover after compensation has been paid are actually not subject to the self-employment tax.
There is always one underlying question when it comes to paying oneself compensation if conducting work for the business, and that is, “What is a reasonable compensation?”
Several factors are taken into account when determining what constitutes as reasonable, and courts have generally looked at the same factors each and every time to see if the shareholder/employee is paying him or herself an appropriate salary. Some of these factors include the following:
- What others in the industry who are conducting similar services would be paid
- What other payments have been made to the shareholder/employee, i.e., distributions
- What other non-shareholder employees make for similar services
- The training and background of the employee, i.e., years of experience in the industry, educational background, etc.
You will need to ensure that you are not abusing this benefit by paying yourself only tax-free dividends, as the IRS closely monitors S Corps for this abuse of power.
Other Benefits of an S Corp
There are other benefits to operating as an S Corp, and these include the fact that an S Corp can maximize its deductions. Under Section 179, S Corps can deduct up to $25,000. Some examples of deductions in this section include the following:
- Bonuses paid to all employees regardless of the amount, as no threshold applies here
- Small purchases of $500 or less (per purchase)
- Business repairs, i.e., replacing a roof
Furthermore, a small business with gross receipts amounting to less than $10 million per year can take advantage of the safe harbor rules for repair and maintenance, which indicate that buildings with an unadjusted basis of less than $1 million can deduct $10,000 or 2 percent of the building’s unadjusted basis, whichever is less.
Businesses with applicable financial statements can also deduct purchases up to $5,000 each. Therefore, the small purchase of $500 or less wouldn’t apply if you have such financial statements. However, if you don’t have these, then you would need to follow the $500 or less rule.
If you need help learning more about the S Corp tax process, 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.