By Timothy Wingate, Jr., EA, G+F Business and Financial Consulting
I think I’m an S-Corp, so what does that mean, and how can I find out if this is true? These questions are asked every year. My goal is to clarify how and when to use these designations.
So, you’re a construction owner currently running your business as a sole proprietor or SMLLC (single member LLC). Are you ready to become an S-Corp? Start with two questions. Are you paying more than 25.3% in income taxes without considering state taxes or more than 28.2% if you’re paying state income taxes? If you are paying more than the applicable income tax rates, it’s worth going down this road. Do you have a company generating at least 10% to 15% net income/profit after your draws or payments to yourself are considered? If so, you are ready to discuss this strategy with your tax professional.
Becoming an S-Corp, how will this benefit me?
The primary reason construction companies convert to an S-Corp is to save on the 15.3% self-employment tax. For example:
If my business earned $100,000 as a sole proprietor or SMLLC, you would pay federal income tax, self-employment taxes, and state income taxes on the total $100,000. This income is getting beat up by three tax rates. If you become an S-Corp and pay yourself a salary of, let’s say, $50,000. The $50,000 you are paying yourself will get hit with federal income tax, self-employment taxes, and state income taxes. The other $50,000 left in the company’s bank account will only be hit with federal and state income taxes, not self-employment taxes. This will give you a possible tax savings of $7,650.
How to set up an S-Corp properly?
You may be asking yourself what is needed to set this up properly. First, you need an EIN. Next, you must register your business with your state revenue department to pay reemployment taxes and other state business requirements. Thirdly, set up payroll for yourself; you must pay employment taxes and file a quarterly and annual payroll tax return. Next will be to have your tax-professional file a timely form 2553 to make the S-Election. If you want the S-Corp status for the current year, this form must be filed by March 15th. Once the IRS approves your S-Election, you will receive a letter stating your S-Election effective date. Lastly, I recommend scanning this letter into a cloud document storage like Google Drive, Dropbox, etc., if you want to keep this letter. Send this letter to your tax professional so they can also store it in their records.
Now there are three major IRS compliances to consider by having the S-Corp status.
If you ever lose or voluntarily remove this status, you lose it for five years. You will no longer file a form Schedule C for your business, which is generally filed with your individual tax return. Compliance #1 you need to file a form 1120S for your business that will be filed or extended by March 15th of every year. You must pay yourself reasonable compensation. Compliance #2 paying yourself reasonable compensation requires you to set up payroll, and I highly recommend Gusto as a payroll provider. The IRS hasn’t given us guidance or clarity on determining reasonable compensation for an S-Corp Owner. Here at G+F, we can conduct a reasonable compensation analysis; click here to get your analysis. Compliance #3 you need to keep track of your stock and debt basis. Having enough basis determines whether your draws and net income will be taxed. You must have enough basis to take a net loss. In other words, I recommend not converting to an S-Corp if you see consistent net losses yearly.
Can I still deduct my home office and vehicle expenses as an S-Corp?
The short answer is yes. Can you pay these expenses out of your business bank account? The answer is it depends. We will discuss how to deduct these expenses if they are paid from your personal account or business account.
Let’s start with if they are paid from your personal bank account. You need to be reimbursed for these expenses just like any other employee. Remember, as an S-Corp owner, you are considered an owner-employee. The S-Corp needs to have a documented accountable plan; this is a plan that describes how expenses should be reimbursed. First, we need to know what home office expenses are deductible. You will have indirect and direct expenses related to the home office.
Indirect expenses apply to the home, like electricity, water, internet, security, and home depreciation, just to name a few. Direct expenses only apply to the home office, like paint for the office, office furniture, etc… You may be asking how much of the indirect expenses are deductible for the business. We must first figure out what percentage of the expense gets applied to the home office; to do that, we must come up with an allocation. To do this, you must take the home office’s square footage and divide it by the home’s square footage to determine your percentage.
For example, the home office is 300 square feet, and the house is 1900 square feet. 300/1900 = 15.8%. So if the electric bill were $250, the amount allocated to the home office would be $39.50 = $250 x 15.8%.
I want to pay my home office and vehicle expenses from my business bank account. How can I do this? You can follow the same process as mentioned above. This is essentially an accountable plan written, documented, and followed as part of the company’s process. You can also pay from the business account under a non-accountable plan. This means that the amount paid by the company will need to be included in the owner’s gross income. This recorded income will not be hit with social security, medicare, or federal unemployment taxes.
I hope that you now understand what it truly means to be an S-Corporation if it’s the right decision for your construction company, and if you already have made the election, that you know what is required now that you are an S-Corporation.
About the Author
Timothy’s father owned a general contracting business in Florida, and he worked alongside him for many years. Timothy saw the sacrifices he made to keep the business running. Everyone was depending on him. That pressure can get overwhelming at times. But you don’t have to go it alone. G+F can be your trusted adviser who will craft the blueprint you need to set up your business for financial success. He is a Licensed Enrolled Agent authorized to practice before the IRS. Member: Associated General Contractors of America Florida East Coast Chapter; QuickBooks Online Certified ProAdvisor. If you have any questions about this topic or construction accounting and tax, you can contact Timothy by clicking on this link.
