S Corporation Tax Secrets: Benefits, Deductions & Strategies
Your business structure determines how you will be taxed. You need to understand and use strategies that will result in tax savings. Read on to find out S Corporation tax secrets to minimize your tax liability.
The default business structure you get is of the sole proprietor. However, when your business grows you might need to consider comparing LLC vS Corporation so you can choose the best structure for your expanding business.
One of the options is to create an S Corp which is a type of business you can have if you opt for an LLC. It can have a maximum of 100 shareholders. There are several S Corp tax benefits & tax deductions which will give you a tax break.
Tax Benefits Of Filing As An S Corporation
S Corps are pass-through entities that allow you to report your business profits and losses on your personal income tax return. This is similar to how sole proprietors report their income.
Let’s look at the tax benefits of S Corp.
Saves Self-Employment Tax
One of the perks of having an S Corp is that you only pay self-employment taxes on wages, not on the share of your distribution.
Let’s say you are a member of an S Corp with a 30% share of profit. Your annual salary is $40,000. Your company made $250,000 profit in the current year. Only $40,000 will be subject to self-employment taxes. You will not pay any SE tax on your 30% share in the profit which is $75,000,
You might be thinking instead of taking salary I should take distribution to avoid SE taxes. Well, you can’t do this because IRS requires the shareholder who also works for the company as an employee to set a reasonable salary for themselves.
IRS doesn't provide a cut & dried rule for this instead you should use factors like experience, the position, business size & the salary paid for the same position at your competitors to come up with an estimation. Remember whatever amount you decide you need to justify it when the taxman comes for the audit.
There Is No Double Taxation
This is one of the important tax advantages of having an S Corp. Normally corporations & C corporations are double taxed which means they pay after-tax profits to their shareholder who then reports & pay taxes again on their personal tax return.
Creating an S Corp is a way to avoid this double taxation. The S Corporations distribute their profit to their shareholders who then report these on their personal tax returns and pay taxes on them.
Step up your Cost Basis By Selling Your Home To S Corp
One of the little-known S Corporation tax secrets is when you sell your home you get an exemption on capital gain amounting to $250,000 if you are single and $500,000 if you are married.
Let’s consider this you bought a home for $300,000 some 15 years ago and you sold it for $1 million dollars. Had a gain of $700,000. You will either pay tax on $450,000 if you are single or $200,000 if you are married. If you had sold your home to S Corp the cost basis would have been the current fair market which will result in no or low capital gain tax.
It is important to consider that this is a related party transaction which means the chances of this coming under scrutiny is higher. But the IRS won’t flag you for this one.
However, you need to have enough evidence that you have followed all the rules such as inspection of the home, and hiring an attorney just in case you have to prove that this was a fair deal.
Make sure to keep track of the property taxes that might increase and outweigh the benefit of stepping up your cost basis.
Working As A Family Team Can Save Taxes
There are several ways you can arrange compensation for your family members for helping you in running your S Corp which can result in tax savings.
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The Social Security Wage Limit.
The 6.2% social security payroll tax does not apply to any income you earn which is in excess of capped amount. For 2022 this amount is $147,000. This means that the maximum social security tax one can pay is $9,114. ($147,000 * 6.2%).
How this can help you in saving taxes? Well, If your spouse is working for your s crop and they have another income source this means they can reach the social security wage limit sooner.
There is no wage limit on medicare taxes. In fact, if your income exceeds $200,000 there is an additional medicare tax of 0.9%.
Make sure to set a salary based on the capability of the person and is comparable with the company in your industry.
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Hiring kids.
Let’s say your son helps you update websites and other technical stuff. You can pay him $12,000 per year. And you are allowed to deduct this from your income.
Be mindful that putting family on payroll means you are more likely to get scrutinized by the tax authority. So be prepared to justify every move you make.
S-Corporations Tax Deductions
You still want to know more ways as to how can an S Corp save on taxes. Apart from the benefits & strategies discussed above, there are tax deductions that s-crop can take to arrive at its taxable income. Some of these are listed below.
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Salaries & Wages.
As an owner of anS Corp, you can deduct your payroll taxes. If you pay yourself a salary that's a deductible expense. Additionally, you can also deduct the salaries you pay to your spouse for running the operation and the kids for helping you. Remember to decide a salary on a fair basis. -
Owner’s Health Insurance Premiums.
You can write off your health insurance premium if you run it through your SCorp. For the owner or the employee who owns more than 2% of the share, you can set up a health insurance plan either by paying the premium for the owner along with the family or reimbursing the owner.
The insurance premiums cannot be greater than the amount you receive as a salary. Note that if you qualify for health insurance through your spouse’s employer then you won’t be able to take this deduction.
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Reimbursed Expenses.
The expenses S Corp reimburses to the owner such as home office expenses are deductible. -
Depreciation of the home you sold to the S Corp.
We discussed earlier how selling your home to step-up the cost basis of the home to get a tax break on the capital gain. There is another benefit of doing that you get to deduct depreciation expense on the appreciated value of the home.
This article revealed some of the S Corporation tax secrets. But to apply these tax-saving strategies it is important to consult a tax specialist who can weigh the cost and benefits of each option and will lead you to the way that will give you legitimate tax benefit