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Tax Tips for Sub S Corporate Structures

Tax Tips for Sub S Corporate Structures

To explain Tax Tips for Sub S concept simplistically: Passive income is income you receive while sitting around, such as  interest from a savings account, dividends from stock holdings, or rents from apartment buildings. (Can’t resist the aside, you also can’t write off rental losses against dividend or interest income even though they are in the same class of income.)

For those of you who get up every day and go to work at your Tax Tips for Sub S business where you sweat and struggle to claw your way to the top, you’re not thinking that it’s “sitting around income.” This has got to be non-passive income, right?

Well… Please note: this is one of the advantages of incorporating as a Sub S Corporation. Tax Tips for Sub S income and losses are treated as passive for tax purposes. Yes, this is counterintuitive, especially if the shareholder in question also has W2 wages and material participation in the entity. Material participation – that pretty much means you go to work every day.

No one ever said the IRS is always logical. Thats why you need Good Tax Tips for Sub S

But still, I wondered if I had missed something in my Tax Tips for Sub S. And because tax law is so complicated, I decided to get to the bottom of it. I discussed my findings with an IRS auditor, a tax attorney, my office mate who is also an enrolled agent, as well as with an individual in the Tax Law Department at the IRS. They all agreed with me.

But the biggest Tax Tips for Sub S is Schedule E itself. Note that rental losses are listed on page 1, line 26; Sub S income is listed on page 2, line 32. What happens next? These two totals are combined and netted out (along with several other line items on the form) on line 42 and transferred to line 17 of Form 1040. This function alone (without any reference to work-sheeting) demonstrates that the principle I outlined is in fact correct. Don’t believe me? Go to www.irs.gov, bring up Schedule E and try it yourself.

So when you, as a Sub S Shareholder, lose $25,000 on your apartment building rentals but earn $200,000 from your Sub S Corporation, you will pay taxes on $175,000. You will not have to carry forward the $25,000 loss on the apartment building and pay taxes on $200,000, after all. You’re going to save a lot of money in taxes because of this provision.

This is a useful tool for the self employed. Once income levels for sole proprietors and partners in a partnership reach the point where rental losses will no longer be allowed (or phased out) and it is otherwise time to incorporate, the Sub S election will be quite the tax-saving device. This device also comes in handy if rental losses exceed the $25,000 maximum allowed under current tax law for passive activities at lower income levels.

But before deciding to incorporate as a Sub S, check all aspects to determine if the structure will suit your needs and psychological temperament. In other words, can you keep up with the rules and the paperwork requirements? Also check with your attorney to make sure this structure is the best form to protect you legally. And check with your tax pro to determine what your tax savings will be.

Other Tax Tips for Sub S not included previously:

1. Income and losses must be allocated to shareholders according to their percentage of ownership;

2. You cannot deduct losses in excess of your investment;

3. You cannot have more than 100 shareholders;

4. Each shareholder must be a permanent U.S. resident;

5. Fringe benefits for more than 2% owners are not deductible at the corporate level – you may take the appropriate deductions for fringe benefits, such as retirement plan contributions and health insurance as an adjustment to income on your individual income tax return;

6. Not all fringe benefits are deductible like they would be if the entity was a C Corporation, e.g. life insurance and disability insurance;

7. As an owner, you must take payroll before you take a distribution of profits.

Speaking of complexities with the tax law, here’s a tid bit for you regarding my recent column about casualty losses: Beginning in 2010, you may take a casualty loss deduction for drywall corrosion. This just makes me shake my head and roll my eyes.

The implementation of this exception defeats the entire premise of no deduction for slow acting damage such as corrosion, dry rot, rust, termite damage, etc. Per IRS regulations, a deductible casualty loss is caused by a sudden and unexpected occurrence. Why the hell should drywall corrosion suddenly become an exception? It doesn’t make sense and it further complicates a tax code that has become far too burdensome and complicated for the average human to comprehend.

 

About 

Gustavo A Viera is the managing partner of Gustavo A Viera, PA. His experience spans more than 25 years. He started his career in public accounting at PriceWaterHouseCoopers where reached the level senior audit manager. His Fortune 500 experience includes positions as CFO – Latin America Region for both Hewlett Packard and Telefonica of Spain. Gustavo also writes a blog twice a week that addresses trending accounting and tax issues. He is an SBA Advisor and teaches workshops for aspiring entrepreneurs. His office is located at One Alhambra Plaza Floor PH Coral Gables FL 33134, and is admitted to practice in the State of Florida as a licensed Certified Public Accountant. Gus welcomes questions and he can be reached at 786-250-4450.

About the Author

Gustavo VieraGustavo A Viera is the managing partner of Gustavo A Viera, PA. His experience spans more than 25 years. He started his career in public accounting at PriceWaterHouseCoopers where reached the level senior audit manager. His Fortune 500 experience includes positions as CFO - Latin America Region for both Hewlett Packard and Telefonica of Spain. Gustavo also writes a blog twice a week that addresses trending accounting and tax issues. He is an SBA Advisor and teaches workshops for aspiring entrepreneurs. His office is located at One Alhambra Plaza Floor PH Coral Gables FL 33134, and is admitted to practice in the State of Florida as a licensed Certified Public Accountant. Gus welcomes questions and he can be reached at 786-250-4450.View all posts by Gustavo Viera →

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