We’ve been talking a lot about business structures this month as part of the Wednesday Coaching. The S Corporation, or even better, an LLC taxed as an S Corporation (LLC-S) is very popular with businesses these days.
The S Corp provides tax savings and asset protection for the shareholder. An LLC-S provides tax savings, asset protection for the shareholder and protects the business from lawsuits that might hit the shareholder personally.
There are a lot of things to discuss when it comes to setting up your business strategy.
When should you have a C Corporation?
Is an LLC-S better than an LLC with default taxation for you?
What benefits can your business provide to you?
What state should you form your entity in?
And that’s just the beginning.
There is a reason why we talk about business structures in the Wednesday Coaching sessions. It’s an important part of your tax strategies and it will evolve as your business changes. The more you know, the less tax you pay and the more money you keep.
In this blog, we’re going to look at two specific issues that the IRS is watching for S Corps and LLC-Ss.
If Your S Corp Has a Profit:
If your S Corp has a profit, the IRS will want to see that you, the owner, draw a salary from the S Corp.
The salary needs to be “reasonable” but other than that, the IRS doesn’t provide a lot of guidance. How much salary do you need to draw? It doesn’t need to be all the income from the company. In fact it might be less than you’d pay someone doing the same work you do if the business is new, going through changes or has a lower-than-expected income.
This is something you definitely want to discuss with your CPA. The IRS’s main concern is to find people with S Corporations who have income and never draw salaries. It’s easier and costs less in payroll taxes but it’s also not allowed.
You must draw a salary if you have a profit. At least, most of the time you do.
Talk to your CPA or ask about it in the next Wednesday Coaching class.
If Your S Corp Has a Loss:
If your S Corporation has a loss, your tax strategy goal is to make sure you can use that loss as a deduction against your other income.
There are two things that you need in order to deduct S Corp losses:
- You need to actively participate in the business, and
- You need to have sufficient basis.
Active participation means simply that you actively participate in the business. There isn’t a minimum number of hours or clear definition of what that means. Some examples of active participation in the past have been: actively working in the business, managing operations or financial activities, and/or involvement in day-to-day decision making.
There are two different types of bases you may have in your S Corporation, equity basis and debt basis. If you have a loss, you can only deduct it up to the amount of your basis. For example, if your current loss is $50,000 and your equity basis is $20,000 and your debt basis is $30,000, you can only deduct a loss of up to $30,000. That’s the larger of the debt or equity basis. The rest of the loss ($20,000) is suspended until there is sufficient basis in a future year.
If you believe that you may have a loss in your S Corporation this year, make sure you have the basis conversation with your CPA before year end. After year end, you can’t increase your basis and that means losses would have to roll over into another tax year.