S Corporation Implementation and Maintenance Plan
Accounting systemWe believe the best accounting system in the world is the one you will actually use. We recommend QuickBooks Online for all of our clients, due to its ease of use, automation of data entry, and the ability to share financial information with us. The most important component of recordkeeping, though, is to furnish you the information you need to make smart decisions in managing and growing your business.
Reasonable CompensationNow that you own and operate an S Corporation, you become an employee of the entity. The S Corporation will pay you a salary, and you will receive an annual Form W-2. IRS guidelines require the S Corporation to pay you “reasonable compensation” for the work you perform. Our general rule-of-thumb is that your wages should be at least 50% of the cash you are able to withdraw from the business. We can assist in determining the payroll option that best suits your needs.
Business ExpensesTo the extent possible, the S Corporation should pay all expenses associated with the business. If necessary, you can advance personal funds to the S Corporation bank account so there is clear recordkeeping of these business expenses. On those rare occasions when you need to use personal funds to pay an expense or purchase an item for the business, the S Corporation should promptly reimburse you. Otherwise, the IRS has been successful in disallowing these deductions if claimed on your personal income tax return.
SUMMARY - RECORDKEEPING
- Implement an accounting system
- Set up payroll so that the S Corporation pays you a reasonable salary
- S Corporation pays all expenses of the business
Health InsuranceBy far, the most important deductible benefit to the owner of an S Corporation is their health insurance. If handled properly, the S Corporation owner is entitled to a special deduction on their Form 1040 for the cost of health insurance that covers themselves and family members. The action steps needed are as follows:
- The S Corporation either pays the premiums directly, or reimburses the owner for premiums paid personally. The reimbursement should be made before the end of the tax year.
- The premiums are recorded in an expense account titled “SH Health Insurance”.
- The expense for the shareholder’s health insurance is included in Box 1, Wages, on the owner’s W-2. The expense should also be shown in Box 14 of the W-2.
Retirement PlansAs an employer, you have many options for creating and funding retirement plans to benefit you and your employees. We can provide guidance on the benefits, costs, coverage and reporting requirements of each option to help you make an informed choice. The most common types of retirement plans adopted by S Corporations include:
- Simple IRA
- Defined Benefit Pension Plan
SUMMARY – TAX BENEFITSHandle the health insurance properly
Consider a retirement plan to benefit you and your employees
Protecting the S Corporation and Your Personal Assets
Protecting the S Corporation and Your Personal Assets
Protecting Your S Corporation StatusAs a general rule, S Corporations can only be owned by individuals. Allowing a partnership, corporation, or certain trusts to become owners will terminate your S Corporation status and subject future gains and profits to double taxation. Where there are multiple owners of an S Corporation, bylaws or operating agreements should include provisions restricting the transferability of ownership in an S Corporation.
Protecting your Personal AssetsBesides the obvious income tax benefits of an S Corporation, another very good reason to operate your business within a corporation or other limited liability entity is to protect your personal net worth from the risks and potential liabilities that can arise in the operation of your business. To enjoy this protection, however, it is extremely important to understand that the entity is separate and apart from your personal activities. It may be tempting to have the S Corporation pay your home mortgage payment, utility bills and personal entertainment. By commingling, or blurring the lines, between your personal and business activities, you may inadvertently create an opportunity for a business creditor or predator to “pierce” your S Corporation and seize personal assets to satisfy their claim. Your legal counsel can provide more guidance in this area. Because the entity can offer a level of protection for your personal net worth, we generally discourage keeping the following assets in your S Corporation:
- Cash in excess of what is needed to meet reasonable business needs
- Real estate
- Marketable securities
- Investments in entities and assets likely to appreciate in value over time
SUMMARY – PROTECTING YOUR S CORPORATION AND YOUR PERSONAL ASSETSIf multiple owners, bylaws should restrict the transfer of ownership interests
Avoid commingling business and personal funds
Avoid holding securities, real estate, assets likely to appreciate, or excess cash in the S Corporation
Basis for LossesOne wrinkle unique to S Corporations is a limitation on the deduction of losses on your personal income tax return. This is a major reason why we don’t typically recommend S Corporation status unless a business has a predictable, sustainable level of profits. Losses can only be deducted to the extent that the owner has personally invested or loaned money to their S Corporation. Loans from third parties don’t qualify, nor do personal guarantees. The owner has to have “skin in the game” to deduct losses.
DistributionsS Corporations are allowed to make distributions (also known as “dividends) to owners on a tax-free basis. Generally S Corporations don’t pay any income tax. Instead, the profits are included in the owner’s personal income tax return. This happens regardless of whether those profits are distributed. When cash flow is sufficient to distribute those profits to you as dividends, they are not subject to a second layer of income tax to the owner.
SUMMARY – OTHER CONSIDERATIONS
- Contact us in November if the entity has a loss for the year
- Shareholders can distribute excess cash without incurring a tax liability