S-Corp Savings: Investing For Growth And Security

Investing in an S-corp can be a great way to save money on taxes. S-corps are small businesses that are taxed differently from traditional corporations, allowing them to avoid double taxation. By structuring your business as an S-corp, you can take advantage of pass-through taxation, where the business itself is not taxed, and profits are passed directly to shareholders, who pay taxes on their individual tax returns. This can result in significant tax savings, especially in the early years of your business.

Another advantage of S-corps is the limited liability protection they offer. Shareholders are not personally liable for the company's debts or legal claims, providing a layer of protection for their personal assets. Additionally, S-corps may provide tax benefits for owners, such as lower self-employment tax liability.

However, there are also some drawbacks and complexities to consider. S-corps have restrictions on the number and types of shareholders, which may hinder growth opportunities. They also require additional administrative tasks, such as appointing a board of directors, conducting meetings, and maintaining meeting minutes.

Before deciding to invest in an S-corp, it is important to carefully weigh the benefits against the potential drawbacks and ensure compliance with IRS requirements.

Reducing owner's wages

S-Corp owners can reduce their personal payroll taxes by lowering their salaries. This allows owners to take the remaining earnings of the S-Corp as distributions, which are not subject to self-employment tax. However, it is important to ensure that the salary is not dropped below what the IRS considers "reasonable compensation", as a very low salary might flag the tax return for a potential audit. A good way to determine a reasonable compensation is to find reliable statistics on wages for similar jobs in the same area. S-Corp owners often perform multiple roles in their business, so it is important to allocate time spent on each role and apply the appropriate hourly wage rate to calculate a reasonable salary. Proper documentation of this analysis in corporate minutes is crucial in case the IRS flags the return.

Rules for S-Corp Owners' Salaries

The IRS requires S-Corps to pay their owners a "reasonable compensation" for their services. This means that owners must pay themselves a salary that meets a minimum threshold, but the business can also pay more than this reasonable salary amount. The calculation of reasonable compensation is often subject to debate and can depend on factors such as training and experience, duties and responsibilities, time devoted to the business, payments to non-shareholder employees, and comparable businesses' pay for similar services. It is important for S-Corp owners to align their salary with what others in similar roles receive to avoid scrutiny from the IRS.

Advantages of Lowering Owner's Salary

Lowering the owner's salary in an S-Corp can result in tax savings. By taking a lower salary, owners can reduce their employment taxes. Additionally, a lower salary results in lower payroll taxes. However, it is important to note that a very low salary might raise flags for the IRS, so it is crucial to find a balance between tax savings and compliance with IRS regulations.

Strategies for Determining Owner's Salary

When determining the owner's salary in an S-Corp, it is important to consider the time spent on different tasks within the company. The "cost approach" is often advantageous, where compensation is calculated based on the cost of specific tasks performed by the owner. This approach allows for a more accurate determination of reasonable compensation and can result in tax savings for the owner.

Compliance and Audit Considerations

Failure to pay reasonable compensation to shareholder-employees can lead to IRS penalties and affect the Qualified Business Income (QBI) deduction calculation. Shareholder compensation is a frequent subject of IRS audits, and auditors examine the company's books to determine if sufficient wages were paid to the owners. In case of an audit, it is crucial to have proper documentation and a well-prepared case to justify the owner's salary.

Covering owner's health insurance premiums

As an S-corp owner, you can have your company pay your health insurance premiums and deduct them as a business expense. However, there are specific rules you must follow to qualify for this tax deduction. Here are the steps you need to take:

• Establish a health insurance plan through your S-corp: The S-corp needs to set up a health insurance plan that covers you and, if desired, your spouse, dependents, and children under 27. This can be done in one of two ways: the S-corp pays the premium directly, or the S-corp reimburses you for the premiums you paid.
• Include health insurance premiums as wages on your W-2: The S-corp must include the health insurance premiums as gross wages on your Form W-2. These additional wages are subject to income tax but not to Social Security, Medicare, or Unemployment (FUTA) taxes if the S-corp offers insurance to all employees or a class of employees.
• Deduct the cost of premiums using the self-employed health insurance deduction: You can deduct the cost of health insurance premiums when you file your taxes at the end of the year. Use Form 1040 to claim this deduction. However, you cannot take this deduction if you or your spouse are eligible for health insurance through your spouse's employer. Additionally, ensure that the insurance premiums do not exceed the amount of your S-corp salary.

By following these steps, you can reduce your tax burden and take advantage of the tax benefits available to S-corp owners regarding health insurance premiums.

Employing your child

Legal Considerations

It is important to ensure that the work your child performs is bona fide and age-appropriate. The work must comply with the Federal Fair Labor Standards Act (FLSA) and state and local child labor laws. You will also need an Employer Identification Number (EIN) and must treat your child the same as other employees, including paying overtime at the standard rate.

Tax Benefits

By employing your child, you can take advantage of several tax benefits. You can shift income from your higher tax rate to your child's lower tax rate, claiming the standard deduction. If your child's earnings are below the standard deduction, they may pay little to no taxes. Additionally, wages paid to a child under 18 who works for a parent-owned business are generally not subject to FICA, Medicare, and federal unemployment taxes. Employing your child can also increase deductible business expenses and reduce reportable income.

Payment Methods

You have a few options when it comes to paying your child. You can pay them directly, especially if you own an S-Corp, but you must treat them as a normal employee, paying the applicable payroll taxes. Alternatively, you can set up a separate Sole Proprietorship or Single-Member LLC and have your S-Corp contract with this new company, which can then pay your child. This way, you can avoid withholding FICA and federal unemployment taxes.

Investment Opportunities

Other Considerations

While employing your child can have financial benefits, there are a few potential drawbacks to consider. You will need to weigh the additional payroll processing fees, employer payroll taxes, and overall payroll expenses against the tax savings. Additionally, ensure that the work your child performs is genuine and not created solely to justify their employment.

In conclusion, employing your child can be a strategic way to maximize tax deductions and invest in their future. However, it is important to carefully consider the legal, financial, and logistical implications before making any decisions.

Selling your home to your S-corp

If you're considering turning your home into a rental property, you may want to sell your home to your S-corp first. This strategy can help you avoid taxes on the sale thanks to the home-sale exclusion of up to $250,000 in gains ($500,000 if married filing jointly). It will also increase the rental property's depreciable basis, which sets the foundation for greater depreciation deductions in the future.

Here's how it works:

Form an S-corp: This step is crucial as it creates a separate tax entity for your business. It's best to keep the process simple and consult a lawyer to ensure everything is in order. Once you've incorporated, file IRS Form 2553 to elect S-corp treatment.

Sell your home to your S-corp: The sale should be executed using a "contract for deed" or a similar instrument. Remember that the sale must be at fair market value, and you may need an appraisal to prove this. You'll also need to follow traditional sales methods, including using a lawyer or title company to transfer the title, obtaining title insurance, and conducting inspections.

Elect out of installment-sale reporting: By electing out, you're choosing to have the profits on the sale of your home taxed immediately. This is an important step to take advantage of the home-sale exclusion.

Eliminate taxes: You can exclude up to $250,000 ($500,000 if married) of profits from the sale of your primary residence from taxes. This exclusion can help you avoid paying taxes on the gain from the sale.

It's important to note that this strategy comes with certain considerations and potential pitfalls. For example, if there is an existing mortgage on the property, you may encounter a "due-on-sale" clause that requires you to pay off the balance when you sell the home. Additionally, as related parties, the sale of your home to your S-corp triggers the related-party rule for depreciable assets, which changes capital gains into regular income. Consult a tax professional to ensure you're aware of all the nuances and potential traps involved in this type of transaction.

Home-office expense deduction

If you work from home and are self-employed, you may be able to claim tax relief by deducting some of your home costs from your taxable business income. This is known as a home office expense deduction.

To qualify for this deduction, you must regularly and exclusively use a portion of your home for business purposes. For example, if you use an extra room in your house for work, you can only claim a home office deduction for that room, provided it is used exclusively for business.

There are two methods for calculating the home office expense deduction:

• The simplified option: You can claim a deduction of up to $1,500, calculated at a rate of $5 per square foot for business use of your home, up to a maximum of 300 square feet.
• The regular method: This method is based on the percentage of your home devoted to business use. You will need to calculate the percentage of your home used for business activities and then deduct this proportion of your indirect expenses, such as rent and utilities. Direct expenses, such as repairs to your home office, can be deducted in full.

If you are an employee of your own S-corporation, you have two options for handling the costs of a qualifying home office:

• The S-corporation can pay you rent for the home office.
• The S-corporation can reimburse you for the costs of a home office under an "accountable" plan for employee business expense reimbursement.

The second option provides greater tax savings. While the S-corporation can deduct the rent paid to you, you must report this rent as income on Schedule E. However, if you are reimbursed under an accountable plan, the corporation can deduct the reimbursement amount, and you do not need to report this payment on your personal income taxes.

To qualify as a home office, the space must be used regularly and exclusively for your trade or business and must be your principal place of business. This means that you conduct most of your income-earning activities from inside the home office, such as making phone calls, sending emails, and performing administrative tasks.

Additionally, to be considered an "accountable" plan, you must submit expense reports to your corporation that include your home office expenses. These expenses must be for actual job-related costs, and you must provide receipts or other documentation to your corporation to substantiate these expenses.

Frequently asked questions