Don’t Neglect to Pay Yourself a “Reasonable” Salary

A popular reason to file as an S Corp is the ability to avoid having to pay social security and Medicare taxes as an employer — which can be worth about 7.5% of your taxable income — by being treated as an employee of the company (even if you’re the only owner). Instead of paying employment tax on your total net income, you just pay it on a “reasonable” salary you give yourself. It’s important to show you are receiving a salary if you’re the sole “employee”. Otherwise, the IRS will require federal, state, and payroll taxes on 100% of your company’s profits. 

When coming up with this figure, take into account the following factors as set out by the IRS:

• Does your position require training?
• How much time and effort is required for this position?
• How much experience is typically required for this or similar positions?
• What are the going salaries for this or similar positions?
• Does this position receive any non-salary bonus payments?

Remember that “reasonable” goes both ways. Don’t undervalue yourself, but keep in mind that overpaying yourself or even paying yourself what you may actually be “worth” raises your self-employment tax burden.          

Deduct Self-Employment Health Insurance Premiums

Many S Corp owners miss this deduction. If you pay health insurance premiums for your family, include the amount paid by the company as wages in Box 1. This allows you to claim it as a deduction on your personal return. Make sure you don’t put it in Box 3 or 5, though, so it’s not subject to social security or Medicare tax.

Use the Home Office Deduction Wisely

Even pre-pandemic, more and more business owners were realizing the benefits (lower overhead) of working from home. If you did work from home — in an area exclusively designated for work — and haven’t claimed for a home office, you are missing out. Take the square footage of your home office and divide it by the square footage of your home. This will be the percentage of household expenses — utilities, home insurance, mortgage, cleaning, and so forth — that you can write off. Don’t get greedy. Write off your den, sure, but don’t pretend your bedroom or washroom are part of your home office (even if you came up with your best business ideas there).

Make and Follow Your Accountable Plan

Unlike wages, reimbursements for expenses employees incurred in the course of their employment are not taxable. By creating an “accountable plan”, these reimbursements will not be treated as wages and can be deducted as business expenses. An accountable plan contains the guidelines — developed by you — that will explain which expenses qualify for reimbursement and how you will reimburse these expenses. An accountable plan will provide you leeway if, say, you needed to use your personal credit card to make a business purchase or incurred some other legitimate business expense.

Your accountable plan guidelines must:

• Show a Business Connection — the expense must be incurred in the course of business/employment.
• Be Documented — you’ll need documents to show what the expense is and how it relates to the business/employment.
• Be Substantiated — you’ll need supporting documents, such as a mileage log or details of an entertainment expense with the who, where, and why.
• Ensure No Excess Payment — if your guidelines allow you to advance expenses and there is an excess amount after validation, it must be returned, or else the excess amount will be treated as wages.

Technically, there is no rule saying that accountable plans must be in writing, but it makes sense to do so. After all, it should be clear and accessible to employees, and it will be a lifesaver should the IRS question expenses the company reimburses.

Be Smart About Credit Financing

Like any other business enterprise, an S Corp may get loans and credit lines from financial institutions. It may seem simplest to make these arrangements in the name of your S Corp, but you can get a better tax return saving if you borrowed the money directly and then provided a loan to your S Corp. This way, because the S Corp tax liabilities and credits pass through to you in your capacity as a shareholder, any interest payments (for example) associated with the loan also go to you so you don’t end up paying more personal income tax than you need to.

Don’t Miss the Annual Election Deadline

Unless you want to forfeit the tax benefit of your S Corp election for the current tax year, make sure you don’t let the election date pass you by. If you are a brand new business, the deadline to file the Form 2553 is two months and 75 days from the incorporation date for the current tax year. Otherwise, it is 75 days from the start of the tax year in question. 

If you file late, the election will apply for the next tax year. Where you can demonstrate a “reasonable cause” for filing late, you may be able to make the election apply for the current year, but you need to make sure you follow the documentary requirements. Still, as with many things, an ounce of prevention is better than a pound of cure. Put the S Corp election deadline date in your calendar every year, along with a few reminders before that. It is a relatively simple and painless way to avoid the stress and headache of dealing with a missed filing date.

Making Sense of S Corporations

S Corps are not for everyone. Find out if this tax designation is best for your bottom line and how you can leverage the S Corp to grow your business. Contact us today with your questions. We’re happy to help.