S Corp Tax Deductions You Should Know (And How Salary Affects Them)
Common S Corp Tax Deductions (And What to know Before You Claim Them)
Before diving into what your S Corp can write off, it’s important to start with how much you’re paying yourself.
Reasonable Compensation is not just about compliance. It also impacts your ability to take distributions and claim certain deductions.
If you haven’t reviewed your salary this year, now is a good time to check in.
An S Corp is a type of corporate business entity where the tax structure regulations fall under Subchapter S of the Internal Revenue Code. Incorporating a business as an S Corp is a smart way to avoid double taxation since income, losses, deductions, and credits are passed through to shareholders. They are taxed at the shareholders’ personal income tax brackets instead of at corporate rates. Because of this unique tax structure, S Corps are a popular incorporation choice for businesses that want to maximize tax deductions.
Not every business is eligible to file for S Corp status. Qualification criteria include:
- Only allowable shareholders
- Not a foreign corporation
- 100 or fewer shareholders
- Not fall under ineligible corporation status
- Have no more than one class of stock
To file as an S Corporation, Form 2552 must be signed by all shareholders and submit the form to the IRS.
Take Advantage of S-Corp Deductions
Not everything can be deducted as an S Corp, but there is a long list of allowable deductions. The key is to be aware of and understand the S Corp deductions so that expenses can be properly allocated in accounting software. This helps to ensure that the business’s tax accountant can identify all allowable deductions and ensure they are included on the company’s tax return to maximize strategies for business success.
Overview of Available Deductions
Allowable deductions for S Corporations are related to business operations. But even in this seemingly strict definition, there are some broad circumstances, so read carefully the common S Corp deductions that are available.
Common S Corp Deductions
Home Office
Many small S Corporations operate from home. The home office deduction allows S Corp owners to deduct expenses related to a portion of their home used exclusively for business purposes. Best practice means having a dedicated home office that is not used for personal activities. This includes deductions for mortgage, rent, utilities, and insurance. For the mortgage/rent deduction, a calculation of either/or percentage or square footage allocation is allowed.
Reasonable Salary
The IRS encourages business owners to pay themselves a reasonable salary. Both too-low and too-high salaries will raise a red flag to the IRS and increase the odds of an audit. It’s recommended to learn about the 50/50 rule for S Corp compensation.
Tax Preparation
Preparing taxes for an S Corporation is complex and complicated. It’s recommended to have a tax professional, such as a CPA, to prepare your tax returns. The money you pay to a professional to have your business taxes prepared is in itself an allowable tax deduction.
Insurance
Business insurance products include property insurance, life and health insurance for employees, owners, and shareholders, umbrella insurance, business insurance, E&O insurance, and more. If the insurance policy covers anything business-related, then the premiums are an allowable tax deduction.
Advertising
Advertising and marketing expenses for an S Corp are allowable deductions. These include things like web hosting, website design services, CRM software, digital and print ad space purchases, and more.
Auto Expenses
The business portion of vehicle expenses is tax deductible for an S Corp. If the vehicle is used both in a personal capacity and a business capacity, then only the business portion is deductible. For this reason, it’s considered best practice to have a separate vehicle for business use, and a different vehicle for personal use. Allowable vehicle expense deductions include gas, electric charging costs, maintenance, repairs, parking fees, road tolls, and more.
Charity
Charitable contributions are allowable tax deductions for S Corporations, with caveats. The recipient must be official and have a tax ID, i.e., a certified non-profit or not-for-profit. Contributions may be in the form of cash, cashable assets (stocks, bonds, etc.), goods or services. Finally, the total allowable deduction may not exceed 10% of the S Corp’s taxable income.
Employee Compensation
Employee compensation is also an allowable deduction. This includes payroll and employee distributions such as holiday bonuses, as well as certain other employee compensation.
Legal
Legal fees necessary for business operations, such as contract negotiations, litigation, and legal advice are deductible for S Corporations. It also includes smaller legal expenses, such as notary services and form filing fees.
Lesser Known Deductions
S Corporations can optimize tax savings by leveraging lesser-known deductions. By effectively utilizing deductions, businesses can reinvest in growth, innovation, and employee benefits.
To maximize legal tax deductions don't miss these lesser-known S corp tax write-offs, which include:
Association / Membership Dues
Many business owners must either pay association dues or belong to memberships in order to keep their license. All dues paid to professional associations and trade organizations are deductible. In addition, the cost of educational credits are also deductible.
Retirement
Contributions made by the S Corp to employee retirement plans, including 401(k)s and IRAs, are deductible. This helps in providing retirement benefits for employees while reducing taxable income.
Independent Contractor
If the S Corp hires independent contractors to do certain work-related tasks, such as freelance work and consulting, those payments for services rendered are deductible. Note that these payments don’t fall into the category of employment compensation, since independent contractors are not employees.
Business Meals/Entertainment
Fifty percent of the cost of business meals and entertainment expenses directly related to business operations can be deducted. This includes meals with clients, business lunches, and expenses related to entertaining clients and prospects.
Supplies & Gifts
Business expenses related to the operation of the S Corp are deductible. This includes everything from Post-It notes to pens, to copiers and more. Client gifts are also tax deductible, up to $25 per client.
Transportion
Even if the business vehicle isn’t used, certain costs of business transportation can be taken as an allowable deduction. This includes expenses such as ride-sharing services (Uber, Lyft, etc.), trains, shuttles, buses, car rentals, and more.
Hotels
For business trips, where the trip lasts overnight, hotel expense deductions may be taken. Room service meals are deductible at the same rate as business meals.
Final Thoughts: Your Salary Drives Your Strategy
Claiming deductions is important, but it all starts with paying yourself the right amount.
Your Reasonable Compensation affects what your S Corp can deduct, how much you can distribute, and how your return will be viewed by the IRS.
If you’re not sure where to start, Tuesday Accounting can help.
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