Year-End Tax Planning for S-Corporations – December 2013

At this time of the year we are working hard on tax planning and preparing for the upcoming tax season.  One of the areas that require significant attention is properly planning for our S-Corporation clients.  An S-Corporation is a designation in the IRS tax code that changes how a corporation is taxed.  If a corporation (created under the state law) applies for, and is granted, S-Corporation status by the IRS, it is no longer taxed at the corporate level.  It becomes a “flow-through” entity and the earnings from the corporation are taxed at the shareholder level on their 1040 tax return. Also, other entities such as a limited liability company (LLC) can request to be treated as an S-Corporation for tax purposes while remaining an LLC for legal purposes.

There are several areas related to S-Corporations that require special planning at year end.  When Congress enacted the S-Corporation statutes, there were several quirks that were created that affect primarily S-Corporations that seem a bit inconsistent with other areas of the tax code but, nevertheless, require that they be properly accounted for.  I will cover several of these and a few other areas that you need to consider if you are an S-Corporation owner or intend to be one.

OWNER SALARY

The profits of sole proprietorships, partnerships and LLC’s are subject to two different taxes; income taxes and self-employment taxes.  When one of these entities decides to be treated as an S-Corporation, the residual profits are no longer subject to self-employment taxes.  We often hear from people in this situation that state how great this is as they can save significant taxes.  This is true to a degree. However, offsetting this tax savings is the fact that an owner of an S-Corporation must pay him or herself a “reasonable” salary commensurate to the services provided to the corporation.  The salary is subject to employment taxes, so in affect, only the portion of the residual profits of the corporation not allocated to the salary is subject to self-employment taxes.

The question is what constitutes a “reasonable” salary.  There is no absolute answer to this question.  There are several court cases that have been settled whereby the courts looked at the owner’s position in the company and imputed a salary based upon what they thought the value of the services were that the owner provided to the company.  In other words, what would you have to pay someone else to replace you so that all you were doing as the owner was earning the residual profits of the company without providing any services to the company.  The IRS also takes into consideration things such as distributions, repayment of loans and other cash that flows through to the owner when attempting to determine what constitutes a reasonable salary.  Suffice to say that this is an area that the IRS believes is subject to significant abuse and that they are paying close attention to this.  Thus, you need to make sure you have justification for how you determined your reasonable salary.

S-CORPORATION MEDICAL INSURANCE

Self-employed individuals (sole proprietorships, partnerships, LLC’s, etc.) are eligible for a special rule allowing them to deduct medical insurance premiums for the company owners and their families in a special manner that does not subject the medical insurance premiums to the medical deduction limitations of schedule A from form 1040.  This is a significant benefit.  However, owners of S-Corporations are not technically considered self-employed as they are employees of their corporations.  To compensate for this, the IRS enacted rules that would allow the S-Corporation owner to also partake of this significant benefit.  However, the way the medical insurance is paid, recorded and reported has to follow these special rules.  Effectively, the corporation must either pay or reimburse the owner for the medical insurance; a determination needs to be made whether the payment of the owners medical insurance constitutes a discriminatory or non-discriminatory plan (whether this payment is or is not subject to social security and Medicare taxes); and the reporting of the medical insurance must be reflected in the owners W-2 in Box 14. Some of the complexities of these calculations are beyond the scope of this article so suffice to say that the benefit to the owner is significant enough that it must be done correctly and you should contact your tax advisor to verify this.

RETIREMENT PLAN CONTRIBUTIONS

One of the most significant tax saving strategies for a business owner is using retirement plan benefits to reduce taxable income.  An owner of a company can potentially invest significantly more assets into a retirement plan than can a W-2 employee.  However, when it comes to S-Corporations, special rules must be considered.  The amount of retirement plan benefits that you can set aside tax-free  is predicated on earnings that are subject to self-employment taxes.  Whereas all of the profits of sole proprietorships, partnerships, and LLC’s are subject to self-employment taxes (as discussed above), only the owners salary in an S-Corporation is subject to self-employment taxes.  Thus it takes careful planning to optimize the benefit that an S-Corporation owner can realize by paying the appropriate salary.

AT-RISK OR BASIS LIMITATIONS

This is an area that is very complex.  However it can have a significant impact on what, if any, losses an S-Corporation can recognize in a particular year, thereby reducing his or her taxes.  Debt of the company can create basis for the owner, even if it is just personally guaranteed by the owner, in all forms of flow-through ownership except S-Corporations.  Guaranteed debt in an S-Corporation environment does not create basis.  Thus, how you secure that debt can have a significant impact on the losses that can be recognized, and, therefore, current tax savings.

The above areas can be quite complicated and we suggest that you contact your tax advisor for further assistance.  Of course, we are also available to assist anyone or to answer any questions.

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Katie Shaw & Tyler Yadon’s Wedding

Judy and I are pleased to announce that on Saturday, November 23rd our eldest daughter Katie married her best friend Tyler Yadon at the Della Terra Mountain Chateau in Estes Park, Colorado. Katie and Tyler have been dating since they were juniors in high school. The ceremony was a very picturesque Colorado wedding (as you can see from the attached picture) and went off without a hitch. A special thank you to our client and friends Paul & Nenita Pellegrino and Northern Colorado Catering for providing outstanding food and service. We are truly blessed for all of the family and friends that attended.

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Client Spotlight – Home Instead Senior Services

A new feature that we are starting with this newsletter is the client spotlight. We like to promote our clients’ businesses and felt a good way to accomplish this is having one client each month identify the services they provide and how they use Shaw & Associates services to help them move their businesses forward.

Home Instead Senior Care is a licensed non-medical home care agency.  We assist our clients with companion services such as meal preparation, light housekeeping, transportation, and general household services.  We also provide personal care services such as bathing, grooming, toileting, mobility and dementia care.  Our team of professional CAREGivers provide these services for as little as an hour a day, up to 24/7 care.  Whether in a traditional home setting or in a care facility, our goal is to help older adults age in place.

Locally owned and operated by Carol and Mike Maguire, Home Instead has helped thousands of families throughout Northern Colorado since 2001.  In November of 2013 our office delivered its two millionth hour of care.  This means the world to our team, as every hour of care is an hour of peace of mind to local families.  To be able to relieve the tremendous burden and stress of being a family caregiver, if only for a few hours, brings us great satisfaction.  We also feel very blessed to be involved with many local non-profits, especially those who help out the aging population.

We have found our partnership with Shaw & Associates to be extremely helpful.  Kevin and his team have been actively involved in numerous projects to allow us to focus our time and attention on our business.  We have utilized Shaw & Associates for business and personal tax preparation and filing, bookkeeping services, tax planning, business planning, compliance, business valuation, and also for QuickBooks training.  Shaw & Associates also has assisted us in personal retirement planning and helped to set up our 401(k) for 300+ employees.  To say that they are a full service firm is a tremendous understatement!

Kevin Shaw is more than just a CPA to us.  He is a friend and a valued member of our team.  We can’t imagine what life would be like without Shaw & Associates.  They are like family to us and have helped our agency to focus on what we do best, which is help families.

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