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Lev, Tax Advisor
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Are you currently online? Question about S-corp formation

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Are you currently online? Question about S-corp formation
Submitted: 2 years ago.
Category: Tax
Expert:  Lev replied 2 years ago.

LEV :

Hi and welcome to Just Answer!
Please post your question.

Customer: replied 2 years ago.
Hello Lev,
Question: I work full time as a veterinarian working for an employer. My earnings max out social security taxes already.
However, I also work on the internet and get a good supplemental income.
I am interested in forming some type of corporate entity to do better at writing off expenses than simply putting it on a schedule C which increases my audit risk a lot.
I am also interested in maybe a S-corp so I can add my wife as a officer so I can deduct the health insurance I pay for her and my daughter that I am now paying 100% out of pocket with no deduction.
So, a few questions. First, can it still be worthwhile to form a S-corp even if I will lose some of the benefit of reducing social security tax since I am already paying the max from the other job?
Expert:  Lev replied 2 years ago.
As we are talking about self-employment income - besides income taxes - it will be subject of self-employment taxes. As you already pay max social security taxes on your wages - your self-employment income will be only subject of 2.9% self-employment taxes (equivalent of Medicare taxes)
I do not agree that filing schedule C compare with corporate tax return would affect the risk of audit. We need to verify actual deductions items.
You may not deduct the cost of your health insurance as business expenses. However - under some circumstances - you may deduct that cost as adjustment to your income on 1040. That will only affect income tax liability - not self-employment taxes.
Ever your spouse is listed as an employee - that will not make any difference.
Why are you concern about deducting health insurance for your spouse? What about your health insurance? Does your spouse has a separate policy?

Having S-corporation provides no advantages in deducting business expenses - but might be beneficial for self-employment taxes saving. In your situation - potential saving may not be more than 2.9% of your net business income.
However - there will be additional overhead for filing S-corporation's income tax return and employment tax return. Generally - there will be actual saving if your net income is above $40k-$50k, but because your self-employment taxes are lower - you might need larger net income to have actual saving.
So far - possible benefits from having S-corporation in your situation are questionable, but to be précised - we need to estimate your gross income, business deductions, etc.

Are you deducting business use of your home? If yes - you will be limited to claim that deduction in case of S-corporation.
Please be sure to ask for clarification if needed.
Customer: replied 2 years ago.
Hi Lev,
I have medical insurance, although not fully paid, through my employer. It is too expensive to add my wife. So, I pay for a separate policy for wife and daughter. I was told that I could make wife a co-owner of S-corp give her a reasonable salary and then off set it by deducting the yearly medical monthly premiums I pay for her. Right now, I am paying about $450/month, so it is a sizeable write off if it can be done correctly. In theroy, after wages paid, there could be about another 40,000-50,000 that could benefit from the 2.9% savings as well. I really thought the itemizing certain expenses like meals, travel etc...lights up more on a schedule C than when contained within a S-corp. So, curious about comments of above, as well as, IF what I am saying can be done about adding wife, giving her small salary and deducting health insurance. and if so, would the health insurance reduce federal and state taxes or only self-employment?



Expert:  Lev replied 2 years ago.
The issue is - if your spouse is eligible for medical insurance through your employer - none of her health insurance cost may be deducted as an adjustment to income. In this case - your only option - to deduct that cost as part of other medical expenses on schedule A.

I was told that I could make wife a co-owner of S-corp give her a reasonable salary and then off set it by deducting the yearly medical monthly premiums I pay for her.
That is not correct - because your spouse is considered as indirect owner of S-corporation and if S-corporation pays her health insurance - that amount is reported as her wages.

after wages paid, there could be about another 40,000-50,000 that could benefit from the 2.9% savings as well.
With S-corporation - you have to receive a reasonable wages - you may not avoid paying wages. Thus assuming $40k NET income after deductions - and $10k in wages (assuming that amount is reasonable) - projected tax saving $30k*2.9%=$870.
That would be saving if you will file S-corporation tax return and employment tax returns on your own. If not - I would put aside at least $400-$600 - so your estimated saving will be very small - and I personally - would not advise to use S-corporation.

I really thought the itemizing certain expenses like meals, travel etc...lights up more on a schedule C than when contained within a S-corp.
There is no difference in deducting business expenses for S-corporation or for schedule C - in general the amount you may deduct as your business expenses will be same.

Specifically for health insurance deduction - see www.irs.gov/pub/irs-pdf/p15b.pdf
See Accident or health plan.
Exception for S corporation shareholders. Do not treat a 2% shareholder of an S corporation as an employee of the corporation for this purpose. A 2% shareholder is someone who directly or indirectly owns (at any time during the year) more than 2% of the corporation's stock or stock with more than 2% of the voting power. Treat a 2% shareholder as you would a partner in a partnership for fringe benefit purposes, but do not treat the benefit as a reduction in distributions to the 2% shareholder.

I suggest to provide that reference to the person who told you differently.
Customer: replied 2 years ago.
Hello,
From the link under "exclusion from wages" it is deductible from employee wages.
So, she is not just a shareholder. If given a 'wage' for work performed, than the health should be deductible as a above the link deduction against her "wages". Not just as a shareholder.

Where I am confused is if she is eligible for coverage through my employer. Technically, she could be. But, if she is "employed" by the S-corp, why would that not entitle her to insurance through the corporation?

Expert:  Lev replied 2 years ago.
So, she is not just a shareholder. If given a 'wage' for work performed, than the health should be deductible as a above the link deduction against her "wages". Not just as a shareholder.
You are correct that technically she would be an employee of the S-corporation - that is not an issue.
But because she is your spouse - in additional of being an employee - she will be treated as 2% shareholder of an S corporation because she indirectly owns more than 2% of the corporation's stock.
Because of that S-corporation you may not deduct her health insurance as business expenses and is required to report as her wages on W2 from.

Where I am confused is if she is eligible for coverage through my employer. Technically, she could be. But, if she is "employed" by the S-corp, why would that not entitle her to insurance through the corporation?
See for reference instruction for form 1040 - www.irs.gov/pub/irs-pdf/i1040.pdf
Line 29 Self-Employed Health Insurance Deduction - see page 28:
But if you were also eligible to participate in any subsidized health plan maintained by your or your spouse's employer for any month or part of a month in 2011, amounts paid for health insurance coverage for that month cannot be used to figure the deduction. Also, if you were eligible for any month or part of a month to participate in any subsidized health plan maintained by the employer of either your dependent or your child who was under age 27 at the end of 2011, do not use amounts paid for coverage for that month to figure the deduction.
Example. If you were eligible to participate in a subsidized health plan maintained by your spouse's employer from September 30 through December 31, you cannot use amounts paid for health insurance coverage for September through December to figure your deduction
.

Sorry if you expected a different answer.
Besides deducting business expenses - you may have a retirement plan for yourself and for your spouse (if she is also participate in your business activity) - that will allow you to defer (not avoid!) some taxable income.
Customer: replied 2 years ago.
No, it does answer.
Finally question, which you can answer tomorrow if getting late.
So, it really doesn't seem like I have a lot of good options because I am employeed and paying the max social security, many deductions I can take whether S-corp or not, and it is quite clear due to my health insurance availability to wife (although it sucks horribly), that S-corp is going to give me enough advantages.
But, are there any other options in my case where I could "improve" the deductions at all having both employeed and self-employeed income? Any chance to add wife under a LLC or partnership or something to try and get something else for less?
If not, do you have any rough guidelines on "reasonable" percentages of gross income I could take for various expenses on a Schedule C without raising much alarm?

It actually seems like I would be a low audit risk since I pay the full amount out of the first job, that they wouldn't really be interested in my return unless I did some crazy!!! deductions.

Thanks
Expert:  Lev replied 2 years ago.

Several notes...

1.

Because you are employed and make relatively large wages - your self-employment taxes are relatively low - and your prospective saving from using S-corporation is also low. That is your special circumstances.

2.

To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.

That in general - doesn't depends on the type of legal or taxing entity of your business. So just having S-corporation doesn't provide any additional deductions. As long as you have expenses and these expenses are both ordinary and necessary - they are deducted against your gross business income.

If you have no expenses - could NOT "improve" the deductions by having a separate business entity.

3.

To be honest - there are some differences how expenses are deducted. Just an example - as I mentioned above - using your home for the business. If you are self-employed - your home office expenses may be directly deducted against your business income on schedule C.

With S-corporation - you are an employee - you still may deduct your home office expenses - but as on Schedule A (Form 1040) - that will not affect your employment taxes. You can only claim these expenses as a miscellaneous itemized deduction subject to the 2%-of-adjusted-gross-income limit.

So this particular deduction - while deductible with either S-corporation and solo proprietorship - is less advantageous in case of S-corporation.

This example illustrates how your special circumstances may affect possible tax saving. Of course - if you do not deduct home office expenses - that issue will not be relevant.

4.

There is no "reasonable" percentages of gross income - all depends on your specific circumstances. Your deductions may be more than your income - but if you report losses for three years - the IRS might question if your activity is a business or that is a hobby. As long as your activity generates net income - there should not be any issue.

You also may not deduct "percentage" - you should have qualified expenses.

I might suggest to come up with the list of all your expenses that "might" be related to the business and analyze if these expenses at least partially satisfy "ordinary and necessary" test - and could be deducted.

5.

As long as you have not made up deductions - I do not see any issues - and there is no reason to be scary of the audit.

In additional, because your self-employment taxes are lower - possible additional tax assessment is less - and the risk of the audit is also lower.

So your situation is not as bad as you might feel...

Customer: replied 2 years ago.
Wonderful.
Some bonus to come as well since you have been so helpful.

How about a C-corp?
I think for me it is very interesting. First, the number of hours I work on Justanswer and some assistance from my wife, I could easily justify that the payout would be all salary and no dividends. I could actually justify a very high salary and no dividend. Therefore, correct me if I am wrong, if there is no dividend and all corporate earnings are paid out in salary, there is no double taxation. There is no corporate tax to pay? That is especially important for me, as I believe veterinarians can be classified as "personel service corporations".

But!
The C-corp, again correct me if I am wrong, would ALLOW my wife to be a employee, and then I can fully write off all her medical costs and premiums, whether eligible with my other employer or not.

What do you think, IF I can legitimately move all corporate earnings to salaries?

Lastly, how does it work with writing off "expenses" in a C-corp. Can I take those expenses write offs as a pass through on individual taxes? Or, is it applied before salary distributions. Wasn't sure how that worked.

Thank you so much for your assistance.
Andy
Customer: replied 2 years ago.
I should add:
I do understand that any extra salary for wife as a employee would be now subject to extra SS that I would have not otherwise paid. That would have happened with S corp anyway.

I also do understand that I would lose some benefit in the medicare savings with S corp although not that much.

I was simply trying to make an argument that a C-corp, because of my unique situation, could actually be advantageous since I also already pay max SS.

Thanks

Expert:  Lev replied 2 years ago.

Hi Andy,

1.

C-corporation is a separate legal and taxing entity.

While you own shares of C-corporation - it has its own way to deduct business related expenses and will file its own tax return.

To be deductible - that should be C-corporation's expenses - not your expenses - that is very important point.

Unlike S-corporation - C-corporation is not required to pay wages. C-corporation may pay wages and MAY deduct reasonable wages (those you may justify).

2.

As I mentioned above - C-corporation may deduct only its own expenses.

If you are an employee - C-corporation may reimburse your job related expenses under so-called accountable plan. An accountable plan is not taxable to your employee. Amounts paid under an accountable plan are not wages and are not subject to income tax withholding and payment of social security, Medicare, and Federal Unemployment (FUTA) Taxes.

In order to qualify as an accountable plan, your reimbursement or allowance arrangement must require that your employees meet all three of the following rules:

(1) There must be a business connection to the expenditure. This means that the expense must be a deductible business expense incurred in connection with services performed as an employee. If not reimbursed by the employer, the expense would be deductible by the employee on his/her 1040 income tax return.

(2) There must be "adequate" accounting by the recipient within a reasonable period of time. This means that your employees must verify the date, time, place, amount and the business purpose of the expenses. Receipts are required unless the reimbursement is made under a per diem plan.

(3) Excess reimbursements or advances must be returned within a reasonable
period of time. Reasonable depends upon facts and circumstances.

3.

A qualified personal service corporation is taxed at a flat rate of 35% on taxable income. You generally may have taxable income zero and avoid corporate income taxes and dividends all together.

I would still investigate your state corporate tax liability.

A corporation is a qualified personal service corporation if it meets both of the following tests.

-- Substantially all of the corporation's activities involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting.

-- At least 95% of the corporation's stock, by value, is owned, directly or indirectly, by employees performing the services listed above, retired employees who had performed such services, any estate of an employee or retiree described above, or any person who acquired the stock of the corporation as a result of the death of an employee or retiree (but only for the 2-year period beginning on the date of the employee's or retiree's death).

4.

You are correct that C-corporation may deduct health insurance premiums paid for employees - but not reimbursment for the cost. That should be plan established under C-corporation. I might suggest to contact your health insurance provider and verify if teh health insurance woudl be established under teh name of your C-corporation - will or will not that affect the cost?

5.

Overhead expenses for filing income tax and employment tax return for C-corporation mioght be a little higher for C-corporation. As a raw estimate - I would put $1k aside for that reducing your projected tax saving.

So as you are currently paying about $450/month - total $5400 in after tax dollars. Assuming you are in 25% tax bracket plus 2.9% self-employment taxes - total ~28% - you need $7500 income - so your possible tax saving would be $2100.

Minus overhead expenses fro keeping C-corporation ~$1000
Minus additional employment taxes for your spouse - ?
So far - your potential NET saving doesn't look very attractive...

However - you might have other reasons for having C-corporation?

 

Customer: replied 2 years ago.
No other reasons other than kind of the points we have already hashed out.

So, final words...
It almost sounds like you at one point suggested:
Stick with Schedule C as a sole proprieotor. Claim wife as a employee. Pay her enough to fully offset her medical expenses.

Also, I got the impression you were inferring that I may already be a lower target for audit as a result of paying the full FICA taxes on the primary job and that I am NOT just a self-employed with huge write offs?

Expert:  Lev replied 2 years ago.

If you were my client - I would recommend to stick with schedule C.

You would only move to a different business structure if ther e are specific reasons or benefits. There is no to complicate things and your tax situation without reasons.

No need to claim your spouse as an employee - there will be additional employment tax expenses with no benefits.

Still you will not be able to deduct her health insurance for above reasons.

If your employer provides with section 125 FSA - you may fund that account and use it for medical expenses including health insurance premiums.

Another option - to have HSA - fund it with pretax dollars and use the money to pay medical insurance.

FICA taxes have two parts - social security and Medicare taxes. Self-employment taxes are equivalent of FICA taxes. Because on your primary job you max social security taxes - your self-employment taxes on additional business income will be lower. That is your advantage of being an employee.

To deduct a certain expense - you need to have that expense. You may not simply claim "write offs" without paying expenses. I still suggest to evaluate all your expenses on subject of their relation to your self-employment activity and verify what may be deducted.

Your understanding is correct - the less possible tax recovery the IRS has - the less your chances to be audited.

 

Customer: replied 2 years ago.
Last question:
How in the world is it that JA is not required to issue 1099's?
Second, why wouldn't they?
Is there some incentive not to issue them for JA's benefit?

Thank you
Expert:  Lev replied 2 years ago.

How in the world is it that JA is not required to issue 1099's?

That issue was discussed in the forum specifically by Tax experts - there was no clear answer. But the administration did not want that discussion to continue.

Second, why wouldn't they?

I may not say for sure - but I think because there are many non-US users and reporting would create huge and unnecessary overhead.
Is there some incentive not to issue them for JA's benefit?

Besides overhead - I do not think there are any incentives.

Lev, Tax Advisor
Category: Tax
Satisfied Customers: 23251
Experience: Taxes, Immigration, Labor Relations
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