The S Corporation has become one of the most popular entities for small business owners because it offers many of the protections of incorporation without being subject to some of taxes faced by other kinds of companies. S Corps do not pay taxes at the company level and profits passed to shareholders are not subject to self-employment tax.
But with all its benefits, we find a few mistakes that many business owners make in connection with their S Corporation. We collaborated with Chet Syverson, owner of Curated Accounting, to bring you 5 tips to avoid these common mistakes.
1. Compare costs and benefits before choosing an S Corporation.
S Corporations are often highlighted by tax planners because they offer a reduction in self-employment taxes compared to partnerships, sole proprietorships and other entities. However, S Corps come with additional tax return and payroll costs that must be considered.
We recommend budgeting about $2,000 per year for added administration costs, but these costs vary based on number of employees and partners. Before choosing an S Corporation, compare these added costs with your potential tax savings.
2. Properly report your health insurance premiums.
Paying health insurance premiums for your family? You can claim a deduction, but there’s a technical difference to be aware of when filing as an S Corporation as compared to a sole proprietorship or partnership.
When filling out your W-2, you’ll include the amount paid by your company in Box 1 as wages, which allows you to claim the self-employed health insurance deduction on your personal return, but not boxes 3 or 5, as it’s not subject to social security or Medicare tax. This is regularly missed by S Corporation owners and can result in losing this valuable deduction.
3. Maintain and comply with an Accountable Plan
An “Accountable Plan” is a plan that meets the IRS rules regarding expense reimbursements for employees. If you’re an owner-employee of an S Corporation, this means you, too! These rules prevent business owners from stacking up years of unreimbursed expenses and trying to claim them in a high tax bracket year.
Accidentally put a business charge on a personal card? Need the S Corp to reimburse you for the business use of your phone? The S Corp can reimburse you for these expenses and claim them as a deduction…if you’re in compliance with an Accountable Plan.
4. Look carefully at the Home Office Deduction
In today’s environment, more and more business owners are working from home. Many S Corporation owners overlook the home office deduction because they don’t think they qualify. If you have a space in your home that is used exclusively and regularly for business purposes, even if it’s not an entire room, your S Corporation can reimburse you for the business use of your home.
Divide the square footage of your business space by the square footage of your home to determine the percentage of expenses you can write off. If you use 500 square feet of a 5,000 square foot home for business, you’re using 10% of your home for business. This means your company can reimburse you for 10% of the indirect expenses to maintain your home, which include utilities, insurance, mortgage interest, HOA dues, cleaners, and more. As we learned in the previous point, make sure in line with your Accountable Plan!
5. Don’t miss out on the “Augusta Loophole”
The Augusta Loophole, or 280A deduction, gained popularity when residents in Augusta, GA cleared out their homes each year for the PGA Masters Tournament, rented their homes at high rates to fans, and weren’t required to pay taxes on their rental income. Why? IRC 280A deems income generated by renting a home for less than 14 days to be non-taxable.
How does this apply to you? You can rent your home to your S corporation for business events up to 14 days out of the year, claiming a deduction for the rent paid, and the rental income is non-taxable to the owner. If you qualify, this turns taxable income into non-taxable income.
An S Corporation offers many benefits for the right situation, but this decision should be made carefully with the guidance of your tax advising team. If this is the route you decide choose, you now have the tools to avoid these 5 common mistakes!
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