A famous quote by Robert A. Heinlein is “When one teaches, two learn.”
In my experience, with almost every tax return I prepare or tax class I teach, I learn new ways to help others -financially. The missed opportunity for one can become Teachable Moments for others.
Single Member LLC- Transition from Schedule C to S-Corp:
Seasoned Sole Proprietors know they have a variety of “ordinary and necessary” business tax deductions available to them. These may be used long enough that they may just seem “normal” and like something that everyone gets – all the time.
The Sole Proprietor may been rolling along, doing great, reached a certain level of net income and decided to change their tax filing classification from a Sole Proprietor to an S-Corp. They file form 2553, receive IRS approval, determine “reasonable compensation” and set up payroll for the Employee Owner.
Let’s pretend the above occurred in 2017 and in 2018 they asked me to help them with their 1st S-Corp tax return (1120S) and with their personal Form 1040 because the K-1 and other rules were new to them. I accept.
When preparing tax returns, it is always a good idea to compare the previous years returns with the current tax return because it helps to identify any significant changes. During this process, I identified 2 deductions used in 2016 that we could not use, retroactively for the 2017 return. For clarification, I am using the term “retroactively” because the 2017 tax year was closed, the W2’s issued, and we were now in 2018. They two (2) deductions identified were:
- Self Employed Health Deduction
- Home Office Deduction
New Tax Classification = New Tax Rules
A SMLLC, filing their IRS Form 1040 & Schedule C as a Sole Proprietor /Disregarded Entity wears one (1) “Taxpayer Hat” – their own
S Corporation Shareholder-Employees wear 2 “Taxpayer Hats”
- Employee who receives a W2 for their reasonable compensation earned during the year
- Shareholder/Owner may receive distributions from earnings and profits
Most of us know that we cannot co-mingle business and personal funds- they need to be separate.
- The Schedule C taxpayer can use a business check to pay for a business flight for her business travel
- The Employee Shareholder taxpayer needs to use a new process to obtain reimbursement for business travel
I understand this may sound strange, particularly if you are the only shareholder- “it is only me and it is all my money”. The IRS does not look at it like this- let’s use Starbucks as an example. Can a Starbucks employee write a business check to pay for their personal business expense? Usually – they cannot.
Employee Owners can use Accountable Plans to reimburse their allowable personal business expenses such as mileage, travel and meals. In my story, this was not an option for 2017 because the W2’s were already issued. However, this can be set up and used in the 2018 tax year.
- S Corp Employee Owners must prepare expense reports and submit them to your Employer (company) on a regular basis
- The S-Corporation issues a business check for the expense reimbursement which can then be deposited in the Employee-Shareholders personal account
My last blog, ‘Tax Reform and Employee Business Expense’, provided information and rules for Accountable Plans. Here are specific tips for the S-Corp Shareholder Employee:
Self-Employed Health Insurance Premiums:
One of the perks of being self-employed is that you can deduct the cost of health insurance premiums as an “Above the Line” deduction (Form 1040, Line 27).
“Above the Line” deductions are preferable because they can apply to everyone and are separate from choosing either to use the Standard Deduction or to Itemize Deductions.
To take this deduction, one of the following statements must be true:
- You were self-employed and had a net profit for the year reported on Schedule C, C-EZ, or F. (Others may qualify too; the focus of this blog is the change from a Schedule C to an S-Corp)
- You received wages in 2017 from an S corporation in which you were a more-than-2% shareholder. Health insurance premiums paid or reimbursed by the S corporation are shown as wages on Form W-2
- The insurance plan must be established under your business. Your personal services must have been a material in- come-producing factor in the business. If you are filing Schedule C, C-EZ, or F, the policy can be either in your name or in the name of the business
- If you are a more-than-2% shareholder in an S corporation, the policy can be either in your name or in the name of the S corporation. You can either pay the premiums yourself or the S corporation can pay them and report them as wages. If the policy is in your name and you pay the premiums yourself, the S corporation must reimburse you. You can deduct the premiums only if the S corporation reports the premiums paid or reimbursed as wages in box 1 of your Form W-2 in 2017 and you also report the premium payments or reimbursements as wages on Form 1040, line 7
If the health insurance deduction cannot be used “Above the Line”, it is reported “Below the Line” on Schedule A, Itemized Deductions, as a medical expense, subject to the 7.5% of Adjusted Gross Income (AGI) limitation.
Home Office Deduction- for the convenience of the employer
- S corporations may be able to use an Accountable Plan to reimburse expenses for the legitimate business use of the home. By doing so, the business can claim a deduction for necessary business expenses, while the taxpayer is allowed to exclude the reimbursements from income
- Discuss your specific situation with your CPA or EA
This blog was written to help Small Business Owners know that there are many aspects to choosing a tax classification. It is so much more than “checking the box” or submitting the form. If you want to learn more, reach out and schedule an appointment with your favorite Tax Professional. They, like me, love to help others save money through legitimate and timely deductions and/or tax planning.
In closing, if you are considering changing your IRS tax classification, I suggest you proceed with “informed caution”. Why? Generally, once an LLC has elected to change its classification, it cannot elect again to change its classification during the 60 months after the effective date of the election. Make sure you want to be “married that long” before you tie the knot and sign on the…dot. (Doted line)
Thanks for reading.
To your success,
Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth though education, strategy, and proactive tax planning. Deb thinks this is the fun part of tax because it makes a financial difference for her clients, their business, and their families.
She offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of phone, virtual, and in-person communications.
E-Mail me @ firstname.lastname@example.org
Facebook: Deborah Ann Fox, CPA
The blog is provided as general information only and should not be considered a substitute for specific advice and services of an Attorney, Certified Public Accountant or Enrolled Agent.