To Be, Or Not To Be an S-Corporation, THAT is the Question:

Whether ’tis Nobler in the mind to suffer the stings and angles of outrageous tax planning, or to take hold against a sea of tax pitfalls, and by addressing them : to not cry, to sleep more soundly.

As CPAs, we come across some pretty poor tax planning and accounting  with new clients.  Sometimes we had to amend  tax returns prepared by another CPA.

Jose Zabrano, CPA addressed the need for better planning concerning the C-corp/S-corp question in How Changes in Corporate Tax Rates Can Affect Choice of C vs S Corp 

Any time you make decisions of this type, you should always work with a CPA, but you should know the basic differences in the two types of tax designations:

1. Who pays the Taxes? Normally the main difference between the two is that C Corporations pay their own taxes at their own rates.  (This of course is the main deciding factor in Jose’s article.)  An S-corporation income or loss passes through to the shareholders’ individual returns where the taxes are paid at their rate.
2. Medical Deductions:We usually deal with closely-held or sing shareholder companies so medical deductions are an issue.  C Corporations usually allow the owner shareholder to deduct their medical insurance and out of pocket medical costs.  S Corporations do not with one exception:  If  2% + (ownership) shareholders want to deduct their medical insurance deductions, they can if you do a tricky W-2 maneuver allowing them to take the deduction on their personal returns.  As CPA s, we still struggle with payroll companies to get this right.  This must be done by December of each year.
3. Tax Basis:Shareholders who want to deduct losses that pass through from their S-Corporations must be careful.  In order to deduct these losses, you must have a “tax basis.” In other words, you must have “skin in the game.”  In its most simplest form, what this means is that in most cases, you cannot deduct losses if your capital account is negative.  As a CPA, we compute basis and at-risk calculations to determine if a loss is partially or totally deductible, or does it get carried forward.
4. Reasonable Compensation:  What’s reasonable?  “Reasonable” is what the IRS says is reasonable, so a CPA must consult you as to your salary and draws in an S Corporation.  This is a hot button for the IRS because shareholders skirt paying payroll taxes on draws.  C- corporations do not pay draws, but dividends which are taxed currently at capital gain rate if they qualify.

As CPA s we see a lot of the same mistakes in S Corporations and C Corporations.  We stress that clients plan during the year so as to not have any surprises.

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the U.S. Department of the Treasury and Internal Revenue Service, we inform you that any tax advice contained in this e-mail (including any attachments) is not intended or written to be used, and may not be used, for the purpose of (a) avoiding penalties under the Internal Revenue Code or state tax authority, or (b) promoting, marketing, or recommending to another party any transaction or matter addressed herein.