S Corp Write Offs: Everything You Need to Know
S corporation write offs are costs that you have incurred while operating your business that can be removed from your income, thus reducing the amount of tax you'll be paying. 4 min read
S corporation write offs are costs that you have incurred while operating your business that can be removed from your income, thus reducing the amount of tax you'll be paying. Every individual with a business knows that "You need to spend money to earn money." One of the things you might overlook is the fact that you can enjoy multiple benefits by spending that money. Starting and growing your business are two valid reasons for spending. Don't forget that a large chunk of money spent on business operations and growth can be deducted when determining your taxable income.
Business Deductions: Critical for Tax Savings
There are two considerations to keep in mind when determining whether business expenses are deductible:
- The expenses are considered ordinary and necessary.
- You have retained all records the IRS needs to process your claims.
Recording deduction-worthy expenses quickly and going over your documents to search for all valid deductions are two simple strategies to reduce your taxable income. Other means of reducing income would be shifting income to a different tax year or taking advantage of tax credits.
Maximizing your deductions is the first step towards increasing your tax savings. Tax deductions are helpful, especially in the first year, but always make sure that these are justifiable from a business operations perspective.
Business deductions have certain thresholds to satisfy:
- Capital asset versus business expense. If an item bought is expected to last for more than a year, it's a capital asset. To cite an example, purchasing copy paper is a business expense but acquiring a photocopying machine is not. Capital assets are taxed differently than business expenses.
- Appropriateness of the expense. Was the expenditure an ordinary expense and necessary for your business operations?
- Relation to a business activity. The Internal Revenue Service (IRS) strictly monitors if taxpayers try to write off items as business expenses that in reality are personal expenses. If an expense is not totally for business, this should be declared under the personal section and only the portion that was used for business should be claimed.
- Records to support the deduction. In order to show that your business expenses are indeed paid, you need to provide documents like receipts and invoices to prove this. Failing to do so may prompt the IRS to calculate your tax liability differently.
What is an S Corporation?
An S corporation is an election under federal tax law where a business first starts out as a corporation or LLC and then chooses taxation as an S corporation. This means that your business has legal status as one entity, but is taxed as an S corporation. S corporations are beneficial for business owners because of the liability protection and personal taxation options they provide.
A corporation or an LLC must meet the following criteria before they can elect S corporation status.
- Be a domestic corporation
- Have fewer than 100 shareholders
- Ensure shareholders are U.S. Citizens, resident alien individuals, estates, or certain types of trusts and tax-exempt entities
- Offer only one class of stock
Entrepreneurs and business owners should have a good understanding of how S corporations save small business owners tax. One of the tax loopholes with S corporation status is that the business owner can avoid self-employment taxes apart from Social Security and Medicare. Employee wages and most employee benefits, including your own, can be deducted as long as you remember to list them as expenses on your Form 1120-S, which is used to file an S corp tax return.
Here's a simple calculation to give a clear example. Let's say your business makes $150,000 in profits per year. With this, you need to pay taxes to the federal government and to your state government. In the typical scenario, let's assume a $15,000 tax payment to the federal government and another $7,500 to the state government. But don't forget the other types of taxes you need to settle. If your business is a sole proprietorship or partnership, you'll need to pay another 15.3% in self-employment taxes. If you run your business as a regular corporation, you also need to pay Social Security and Medicare taxes on roughly 15% of your profits.
For S corporations, the business profits can be split into two categories: distributive share and shareholder wages. Only the shareholder wages will be subjected to 15.3% tax. Suppose your $150,000 profit was split into shareholder wages where you allocate $40,000 as your pay and the rest as distributive share. In this scenario, only the $40,000 will have the 15.3% self-employment tax and about $6,000 for Social Security and Medicare taxes. This means that you're saving around $16,500 by lodging portions of your profit to non-wages distributive share.
With so many potential deductions at your fingertips, you may want to consider finding quality legal advice. If you need help and further information about S corporation write offs, 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 average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.