| Subchapter S corporations can produce big tax | | | | contributing money to the corporation. |
| savings for some small business entrepreneurs. For | | | | Precaution #3: Take Care with the Sec. 179 |
| one thing, by making the election to be treated as an S | | | | Depreciation Write-off |
| corporation, the business pay no corporate income | | | | Small businesses commonly don't depreciate their |
| taxes. And working entrepreneurs often minimize their | | | | fixed assets: equipment, furniture, machinery and so |
| payroll taxes (Social Security and Medicare) by using | | | | forth. In 2009, for example, the typical small business |
| the S corp option. | | | | can expense (immediately write off) up to $250,000 of |
| But the S corporation tax classification--a classification | | | | fixed assets instead of having to depreciate this stuff |
| available to both regular corporations and limited liability | | | | over three, five or seven years. |
| companies--creates some problems when the | | | | This immediate write-off is called a Section 179 |
| economy sinks into a recession. If you own or operate | | | | election because Section 179 of the Internal Revenue |
| an S corporation, therefore, you'll need to take the | | | | Code authorizes and spells out the rules for taking the |
| following precautions in order to continue reaping a | | | | write-off. Section 179 elections provide a wonderful |
| healthy harvest of tax savings. | | | | tax deduction, but there's a gotcha. You can only take |
| Precaution #1: Don't Overcompensate | | | | a Section 179 election if the business entity shows a |
| Shareholder-employees | | | | profit. Unfortunately, you can't employ a Section 179 |
| A first, obvious tip regarding S corporations in years | | | | writeoff to trigger or enlarge a business's operating |
| when profits are down: You often don't benefit by | | | | loss. |
| paying shareholder-employees enough to trigger | | | | In profitable years, this limitation doesn't matter. In a |
| business loss inside the S corp. | | | | tough economy where the business loses money, |
| Now understand--you do need to pay | | | | however, the limitation may prevent use of the |
| shareholder-employees reasonable compensation. | | | | writeoff. And note: Even if your S corp venture |
| Employees logically still get paid even when their | | | | suffers a net operating loss, you might owe income |
| corporate employer falls on hard times. But what you | | | | taxes due your spouse's earned income or outside |
| don't want to do is put money into the corporation just | | | | investments. |
| so you can take it back out again as a salary. This | | | | Precaution #4: Monitor Shareholder Basis in S Corp |
| round-trip transaction doesn't cost you income taxes. | | | | Stock (and Debt) |
| But the transaction does cost you payroll taxes. In | | | | One other quick warning: When an S corporation |
| other words, if you put $100,000 into your S | | | | shows a loss--something that's likely to happen in a |
| corporation so you can pay yourself $100,000 of | | | | recession--S corporation shareholders can often use |
| salary, just moving the money around this way | | | | that loss as a personal tax deduction on their federal |
| creates roughly a $15,000 payroll tax bill. Ouch. | | | | and state tax returns. |
| Precaution #2: Protect the Self-employed Health | | | | However, in order to use an S corporation loss as a |
| Insurance and Pension Deductions | | | | deduction on the shareholder's personal return, the |
| Tough times may mean you want to or need to cut | | | | shareholder needs basis in their S corporation stock |
| shareholder-employee compensation. But before you | | | | and (if applicable) in S corporation debt. |
| get too aggressive, remember that some of your | | | | In a nutshell, the basis limitation rule says that only |
| business and personal deductions depend on you | | | | losses paid for out of a shareholder's personally-made |
| enjoying earned income. | | | | investments or loans count as tax deductions. If the |
| To receive the self-employed health insurance | | | | money that shows up as being "lost" comes from |
| deduction, for example, you do need employee wages | | | | some other shareholder or some outside lender (like |
| at least equal to the health insurance deduction. And to | | | | the bank) the loss deduction may be delayed into the |
| get retirement savings deductions, you also need | | | | future. |
| employee wages. | | | | Seattle tax accountant and author Stephen L. Nelson |
| Accordingly, even in a tough economy where your S | | | | is the author of a series of downloadable do-it-yourself |
| corp doesn't make much money or even loses money, | | | | S corporation ebooks including titles about starting a |
| you may still want to pay yourself modest | | | | Arizona S corporation and starting a Washington state |
| wages--even if paying those wages means | | | | S corporation. |