Timely tax-saving tips and strategies

Tax tip #3

Deducting personal expenses on S Corporation return instead of on 1040
 

If you deduct some personal expenses on your S Corporation tax return instead of on your individual tax returns, you can reduce the amount of salary you’d have to pay yourself as an employee-owner of the corporation. This in turn will reduce the amount of FICA tax you’ll have to pay.

As an officer, you’re required to pay yourself a reasonable salary if you pay yourself from the corporation. What’s considered reasonable varies according to several factors. Read the document [link: http://www.irs.gov/newsroom/article/0,,id=200293,00.html] Wage Compensation for S Corporation Officers on the IRS website for more information.

By reducing your S Corporation income by deductible personal expenses, you can pay yourself a reasonable salary from the remaining income. The salary would then be subject to FICA. However, the amount of salary subject to FICA will be less than if you paid it from the entire corporate income. In this way you’ll pay less FICA tax. And the personal expenses that you deduct won’t be subject to FICA.

For example, let’s say your S Corporation net income for 2011 is $100,000 before paying the shareholder-employee wages, and the corporation pays the following personal expenses on your behalf (which aren’t included in calculating the $100,000 net income):
 

• Health insurance          $10,000
• Self-employed SEP          5,000
• Donation to charity         5,000

Total                             $20,000

After deducting the $20,000 from the $100,000 net income, the corporation can pay you wages of up to $80,000 without incurring a loss. If the above expenses weren’t deducted by the corporation, but on your personal tax returns, you’d have to pay yourself wages of up to $100,000 to cover the $20,000 in personal expenses deducted on your personal returns. The additional FICA tax you’d have to pay would be $2,260 ($20,000 x .0565 x 2).

Note that contributions to your IRA by the S Corporation can only be deducted as salaries and wages. You’d then have to pay FICA tax on that amount, so you wouldn’t be saving money.

This is an idea that I learned about from reading an article by Stephen L. Nelson, CPA called “S Corporation Tax Saving Tips” at http://stenel.wrytestuff.com/swa439273.htm. 

Please be aware that this strategy shouldn’t be abused by paying non-deductible personal expenses with corporate funds and deducting them on the S Corporation’s tax return. I’ve seen small business owners commingle funds in this manner. It can cause you to have to pay interest and penalties should the IRS audit your tax returns. It can also result in your business being valued for less money should you wish to sell it. If the corporation pays such non-deductible personal expenses, such as for transportation and rent, you should reimburse it as soon as possible, preferably within the year the payments are made.