– Due to the current economic conditions, many people are forming small businesses in an effort to produce income. The tax attributes of the S Corporations are very attractive to entrepreneurs, but few truly understand the rules and structure of one of the most complicated tax entities in the United States. Enrolled Agent Tommy Brown recently discussed some of the potential pitfalls of S Corporations, highlighting three common “S Corp” owners and shareholders as well as three danger areas those business owners face.
Brown said the most common failure is the failure to elect S Corporation status by the 15th of the third month of the company. Although many realize that S Corporations must be registered with the state were they are located, they may not know that the election must then be submitted to the Internal Revenue Service in a timely fashion. This mistake is often discovered by the company’s tax preparer the following tax year.
The second common failure is the failure to keep minutes. S Corporation officers must meet at least once a year, and minutes of those meetings must be kept. This documentation must include bank account information, S Corporation election, loans to and from shareholders, compensations, distributions, and any other material matter.
The third common S Corporation owner/shareholder mistake is the failure to separate personal assets from those of the business. One of the main reasons businesses incorporate is to protect the owners personal assets from any negative events that may take place against the business. But the “corporate veil” can be pierced when separate bank accounts are not kept separate. Brown advises owners to not use the corporation as a personal bank account or purchase personal items with company funds. Conversely, items for the corporation should not be bought with shareholder funds.
The first “danger area” Brown highlighted pertained to shareholder loans. He advises that if the corporation chooses to make a loan to a shareholder, the loan must be documented with separate “Due From” and “Due To” figures. The loan must bear interest and a payment plan should be established.
The second “danger area” Brown discussed is shareholder compensation. The corporation must pay shareholders adequate and reasonable compensation for any services rendered for the corporation. Salaries or wages have to be paid before any non-wage distributions the corporation may pay, and the latter form of payment must not exceed the amount of the wages.
In closing, Brown provided guidance on the issue of having an office in the home. He pointed out that this is not a Schedule E item, but a deduction can be taken on Form 2106 of Schedule A. Also, the deduction is limited to 2% of the employee shareholder’s Adjusted Gross Income (AGI) and all 2106 rules apply.
http://www.youtube.com/watch?v=2ScAwNGbo6A
# # #
