Much of tax accounting makes sense. You get income, you pay expenses, you pay taxes on the net income. Other tax accounting issues are not so simple, namely S-corp flow through taxes. In some cases, the difference between paying twice as much tax or not being able to take a significant deduction are simply a matter of following proper procedures. S-Corp health insurance and S-Corp shareholder loans are two areas where you can save a boatload of taxes simply by crossing your Ts and dotting your Is.
Two Simple Ways to cut your S-corp flow through taxes
1. S-Corp shareholder health insurance is one of the most incorrectly done deductions, and in coming years it will cost you big time. The S-Corp can pay for shareholder health insurance, reimburse shareholder health insurance, and even reimburse shareholder Medicaid and Medicare prescription costs. But these amounts must be reported on the shareholder’s W-2 form. This will allow the company to take the deduction as shareholder wages, and the shareholder to deduct the costs on page 1 of their return as an above the line deduction, effectively canceling out the additional wages reported on the W-2. It’s as simple as calling your payroll company and telling them how much shareholder health insurance to report on your W-2.
Here’s the catch. Most payroll companies have those W-2s ready to go within a week of the end of the year. You have to be pro-active and get that figure to them. In the past, we have been able to report the amount on Schedule K-1 after the fact, but the IRS is cracking down and saying no more. If it isn’t reported on Form W-2, your only choice will be to report the amount on Schedule A, which means that for now it will be subject to the 7.5% of AGI floor, and when Obamacare fully implements that will be 10% of AGI. So for example, if your S-Corp made you $100,000 and you paid $10,000 in health insurance, you won’t be able to deduct any of it.
2. Do shareholder loans to your S-Corp right. Capital contributions to the company can be the best way to build basis and take losses. That is because when you repay yourself on a loan to a shareholder loan to an S-Corp with reduced basis due to prior year losses, you have to record a pro-rata share of that loan repayment as income. But where capital contributions are not practical and a loan to the company works, make sure you prepare a physical note. It is easy for shareholders to just put money in and take it out, but without a note the treatment on gains on repayment will be ordinary income subject to your tax bracket.
For example, let’s say you open up an S-Corp and put $100,000 in as a loan to purchase equipment and buildings. That year you take $100,000 in losses against that loan basis, reducing your loan basis to $0. The following year, you pay yourself back $50,000 of that loan and make significant amounts of income from other sources. If you have a note for that loan, the treatment of the $50,000 loan repayment in excess of basis is long-term capital gain taxed at 15%. Without a note, that is considered simply an open account and the repayment will be treated as ordinary income, taxed as high as 35%. This simple step could save the taxpayer $10,000 in taxes on a $50,000 repayment of shareholder loans.
You can read more about structuring shareholder loans to S-Corps here.
As always we are here to help. Don’t hesitate to give us a call if you have any questions.