New S Corp Puppy, What Do I Do Now
By Jason Watson, CPA
Posted Sunday, October 10, 2021
The following is a reprint from a blog post and is a quick glance at some of the housekeeping that is required after bringing home your new S Corp puppy.
Open a Business Checking Account
You will need a separate business checking account for two big reasons. First, most payroll processors (ADP, Paychex, Gusto, etc.) require this per Bank Secrecy Act and Homeland Security rules. Second, compartmentalizing your personal and business worlds is just good accounting practice. If necessary, WCG can rebuild your financial statements and prepare tax returns based on bank statements. If your Nordstrom’s is mixed in with Staples, it gets messy.
Yet another reason for the compartmentalization is preserve the separation of you, the personal, from the business. This might, heavy on “might,” help you in a lawsuit or legal matter.
Set Up Payroll Accounts and Processing
As a shareholder of an S corporation, you wear two hats. One as an investor, and another as an employee. Well, that’s a lie. As a business owner, in general, you wear a million hats… but two of them are investor and employee. Therefore, the IRS requires all S Corp shareholders who materially participate in the business activities to be paid a reasonable salary.
A salary is more than simply writing a check or making a transfer from your business checking account to your personal checking account. With a corporation or LLC taxed as S corporation those payments are owner draws and are now considered shareholder distributions. Payroll is payroll… complete with quarterly payroll filings (941s) and annual payroll filings (940, W-2 and W-3). Let’s not forget the state equivalents.
Of course, WCG can handle all this for you, but if you choose to process your own payroll, we strongly recommend ADP or Gusto. WCG uses ADP.
Alert Clients to Payment Changes
You might have been receiving payments under your name and / or into your personal checking account. You will want to notify your clients or customers accordingly. You will also want to supply a W-9 to them alerting them that as an LLC or corporation taxed as an S corporation, you do not need to be issued a 1099-MISC or 1099-NEC (unless you are an attorney… seriously).
However, this is not a rock you want to push up that hill. If a client or a customer, or some ambitious accountant on the other end of the email thread wants to issue a 1099 to your S Corp, don’t fight it. Simply ensure they are using the business’s EIN and not your SSN. It’s just not worth the brain damage to convince someone otherwise.
Understand Mileage, Home Office, Cell Phone, Internet Expenses
If you previously reported your business activities on Schedule C of your Form 1040 individual tax return, there are some things to understand. As we just mentioned, as an owner of an S corporation you are both investor and employee. Investors cannot typically deduct mileage, home office, cell phone and internet expense. And! Employees can no longer deduct these expenses as well thanks to the Tax Cuts and Jobs Act of 2017 (Form 2106 as part of Schedule A was eliminated).
As such, your S Corp must reimburse you, the employee, for these expenses through an Accountable Plan reimbursement program. While it sounds fancy, the big takeaway here is that these expenses were commonly deducted on your individual tax return, but with an S Corp, these expenses are now employee reimbursements and are deducted on your business entity tax return. We will spend a lot of time on this and Accountable Plans in a bit.
Why does this matter? We commonly prepare and file a business entity tax return just to later have the shareholders want to deduct mileage, home office, cell phone and internet expenses on his or her individual tax return. This is a problem and requires amending the business entity tax return. Yuck.
Please don’t wait until the preparation of your individual tax return to let us know that you have mileage expenses or a home office to deduct.
Understand SEP IRA / 401k Limits and Handling
This can be a big surprise, so please pay attention on this one (pretty please). With business activities reported on Schedule C, SEP IRAs and 401k company contributions are based on net business income after expenses. With an S Corp, they are based on W-2 wages paid to the shareholders. Big difference!
One of the reasons for leveraging the tax benefits of an S corporation is to reduce the amounts of Social Security and Medicare taxes (self-employment taxes)… and that is accomplished by paying a reasonable shareholder salary which is less than the net business income (see our wonderful chapter on Reasonable Shareholder Salary). Here is some math-
A business reported on Schedule C earns $100,000 after expenses. A SEP IRA contribution is based on this $100,000 and generally will be close to $18,587 for the sake of argument (20% of net business income after deducting the employer portion of self-employment taxes and adjusting for the contribution factor).
Next assume that this same business being taxed as an S Corp pays out a $40,000 salary to the shareholder. Your SEP IRA contribution is now limited to 25% of W-2 wages, and would be limited to $10,000.
So, if you are used to putting away large chunks into a SEP IRA, you will be in for a surprise.
Sidebar: SEP IRAs are old school and were used in crisis mode since solo 401k plans had to be set up during the tax year. Thanks to the SECURE Act, solo 401k plans can be set up in March, but contributions may be made and deducted as if the plan existed the year prior. Also! Keep in mind that solo 401k plans are way better than SEP IRAs with higher contributions (basically solo 401k = SEP IRA + $19,500 for the 2021 tax year). See our chapter on Retirement Planning.
Wait! There’s more. Similar to mileage, home office, cell phone and internet expenses, SEP IRA and 401k company contributions are deducted on the business entity tax return. Read that again. Before your corporation or LLC became taxed as S Corp decision, you might have been used to calculating a maximum SEP IRA contribution on your individual tax return; with an S Corp, this calculation and the decision to deduct the contribution is done on the business entity (S Corp) tax return.
Know the Filing Deadlines, Business Tax Payments
March 15. There it is… and this seems to sneak up on small business owners who have not filed a business entity tax return in the past. S Corps (Form 1120S) and partnerships (Form 1065) tax returns are due March 15, or the next business day. C Corps (Form 1120) tax returns are due April 15, or the next business day.
Also, your individual tax return cannot be filed until the business entity (S Corp or Partnership) tax return is completed. Why? An S Corp or Partnership tax return creates a K-1 which must be reported on your individual tax return. Therefore, if you are a DIYer and prepare your own Form 1040, please do not file until you’ve added the K-1 to the tax return.
Some states have a franchise or corporate tax that affects S corporations and other business entities. For example, if you were a sole proprietor last year and this year you created an entity in California and elected to have that taxed as an S Corp, the business will be required pay a franchise tax on April 15. The business might also pay estimated tax payments throughout the year for California’s franchise taxes. Texas also has a franchise tax which is due May 15. Other states have other rules.
Again, there are a bunch of additional due dates and whatnot that might come with your new S Corp puppy.
Attention Late S Corp Filers
Things change a bit if you are filing a late S Corp election during the first few months of the year. Let’s use some dates-
|February 1||Send late S Corp election (Form 2553) to IRS|
|March 15||S Corp tax return (Form 1120S) is due|
|May 1||IRS gives you the green light for S Corp status|
|May 2||S Corp and individual tax returns are efiled|
|July 4||IRS ruins weekend with late S Corp filing penalty|
Note the problem here… you cannot electronically file the S Corporation tax return (Form 1120S) on-time since you do not have approval from the IRS by March 15. No biggie! One option is to paper file the tax returns, but we’ve seen a ton of problems with that. The other options that WCG uses often is this-
Electronically file a tax return extension on March 15 which is naturally rejected (since the S Corp doesn’t exist yet as a tax election).
- Mail a paper extension to the IRS on March 15 which is probably tossed by an otherwise friendly IRS agent.
- Electronically file the S Corp tax return when greenlighted by the IRS.
- Wait for the nastygram from the IRS saying we were late.
- Submit documentation to the IRS showing the sequence of events, and ask for first time penalty abatement. WCG is batting 100% for over a decade on this.
Your mileage might vary, but this gives you a broad perspective of the sequence when we are close to filing deadlines.
Adjust Estimated Tax Payments
One of the primary reasons, if not the only reason, to elect S Corp status is to reduce self-employment taxes (Social Security and Medicare taxes). If your previous accountant or tax return created estimated tax payments based on the previous year’s data, and before your LLC taxed as S corporation election was made, those vouchers will include the full amount of self-employment taxes. In addition, with an S Corp election and the processing of payroll, self-employment taxes now become Social Security and Medicare taxes and are handled directly through payroll processing.
As such, your estimated tax payments will be way too high and will need adjustments; in most cases, we can eliminate the need of estimated tax payments completely and handle all estimated income tax payments within payroll processing by inflating your withholdings to land on tax neutrality (more on that in a bit).
Accounting, Recording Financial Activity
This is an easy one since whatever you’ve done in the past to memorialize your business transactions remains the same. No, you do not need to instantly add a QuickBooks subscription to your world. While we love QuickBooks Online (QBO) since we can collaborate directly with you, if you have historically used Excel, bar napkins or some other accounting platform, then keep on keeping on.
Nothing changes from an accounting perspective with an S Corp. Yes, there are some minor differences when it comes to Capital Stock and the recording of employee reimbursements, but we can chat about that at tax time.
Let’s dive into this a bit more.
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