Video: The Journey from Schedule C to 1120-S | Duration: 3612s | Summary: The Journey from Schedule C to 1120-S

Transcript for "The Journey from Schedule C to 1120-S": Hi, everyone. Welcome to our session today, the journey from schedule c to eleven twenty s. Now if we haven't met before, very good to meet you today and hope to see you in a future webinar. My name is Nadia Rodriguez. I am a CPA CTC, which stands for certified tax coach. I'm a staff tax analyst here at Intuit, where I am part of a team that looks at tax law, tax research to make sure that our products are in compliance. I'm also an author for our tax articles and our media articles in our tax pro center. I am a public speaker, and I do run a solo tax practice where I have clients out of based out of Dallas, Texas. And if you wanna stay connected, I would love to stay connected. I've listed here my Instagram social handle and also my LinkedIn. Hope to stay connected after the webinar. Now we need to go through housekeeping right before our session to make sure that we're all aligned on what it takes to be participating in today's session, how we can get the CPE, CE credit. So first, you know, as long as we can see this session, you do not have any troubles with the ad blockers. Or if you're on VPN, that might not be a good idea because we do have some pop up blocker or pop ups that come up for the polling questions. So those will be important for you to get the credit for attending today's session. So just make sure that you don't have the VPN or those ad blockers that are active. Also, right after our session, we do have a very quick survey that if we can get you to please fill out, that really is valuable feedback for us to shape our future webinars and try to deliver to you the information that really matters. So we would really appreciate if you fill out the survey at the end of the session. And participating in the polling questions, we do have three polling questions during today's session, and make sure that you do answer those polling questions. I will tell you there is no submit button on those polling questions. Just as long as you select one of those answers, doesn't have to be the correct answer, but your participation counts as long as you select an answer. Now the polling questions, you will notice that they might pop up even before I announce them. But if you do not see the pop up questions, polling questions coming up or you're not seeing them on your screen, always check the menu on your right hand side where you see currently the chat, the q and a, the documents tab. There will be a tab for polling questions, and that's gonna come up when I start announcing the polling questions. So if you don't see it anywhere, always go refer to your menu on the right hand side. But, again, make sure that you answer one of those, answers on the polling questions to get credit. A disclaimer before we get started. We know that this session is an educational in nature and should not be construed as tax advice. We do our best to keep you up to date with the tax law and the content on this webinar. But, of course, you know, there might be some pending legislation, pending guidance. Just a disclaimer, it will here to learn education in nature. Now to earn your, CECPE credit, it is, session is eligible for one hour of CECPE for today, and you do have to be present with us for at least fifty minutes. So hang in there, and you do have to answer those polling questions. Again, we have three polling questions throughout today's session. You will receive a certificate at the end of the session. It should come to you through the email that you registered. Now if you're not seeing it, always check your spam, your junk folder. Sometimes they tend to go in there. But if after forty eight hours you're still not seeing your certificate, please email us at the email you see on the list here, pro tax underscore training that into it. Let us know the session you attended, of course, your name and the time and date that you attended our session so that we can get that squared away for you. But always look for that certificate. Again, sometimes it tends to go into your spam, into your junk folder. Our agenda for today, we talked about what the title of this session is, the journey from schedule c to eleven twenty s. What does that journey look like? Do we have clients that are thinking about becoming an s corporation or have talked to us about wanting to become an s corporation? Well, first, we have to lay the foundation. What is an s corporation? How do we determine if that client is eligible to become an s corporation? How do we sustain that s corporation and the election procedures? And also the compliance requirements. Once we do elect to become an s corporation, what compliance requirements must we still maintain and meet? Our first polling question. Now let's make sure that we answer that. It might have already popped up for you. If not, again, try to find it on the right hand side panel. But our first polling question is, what is your primary reason for attending this webinar with us today? Is it to earn that c e c p e to explore new solutions to solve a specific problem? Maybe you do have a client that's coming to you about becoming an s corporation. Are you or you've been thinking about making them an s corporation or you're just interested in in this education of today to learn more about s corporations or just other, right? As long as you provide us an answer, again, there's no submit button. So don't look for a submit button. Just go ahead and select one of those radio button answers and submit your don't submit as a button, but also just answer that question. Again, in the chat, go ahead and and post it if you're not seeing it. We all help each other out. I see how in chat we're very interactive of helping each other out when those polling questions are out. But that's our very first one out of three. Okay. Now with that, let's talk about being interactive in this chat right now. If you can do me a favor, in the chat, go ahead and enter the destination of your most recent road trip. We're gonna start off with road trips. What was your most recent one or maybe the most memorable that you've had? What destination? What city was it? Was it close to the city you're in? Was it far away? Was it a lot of hours? Is it a long road trip? What was the most recent city you have visited on a road trip? Now we can see we've been taking road trips. Right? We're we're not unfamiliar to road trips. They can be stressful at times, but they can be fun. And now it does come with a lot of planning. And the more road trips that we do take, we do know that we become more experienced in these road trips because we start to learn what went wrong with the first road trip to make the next one better, and that's how it goes. Now I will tell you that I've been taking road trips since I was a little girl. But my destination, we would start off first in the city of Chicago, Illinois, and our destination was in the state of San Luis Potosi in Mexico. Now that was a thirty four hour road trip. It was a pretty long road trip for a young age. And it might sound fun, but it was it was a little bit long for my age. Now we did this every summer with my family for eight years, and I will tell you that we traveled in this. There was no AC. There was no, rest area stops. It's very limited. The closest experience that I really got to an overnight stay during this road trip was a rest area. We would just rest for a couple hours. My dad would to get more energy to continue this road trip. But I will tell you that at a very young age, during this road trip, since we would do it every summer, I started to notice patterns on the road. I started to understand where the next gas station was to recognize when the next rest area was. I started to become experienced. I thought that maybe one day, maybe I can lead that type of road trip because I knew the route. I had built that experience. Now when it comes to road trips, like I said, they're a little bit stressful. But as long as we prepare ahead, as long as we're learning from every journey that we're taking, they make it a little bit smoother. Right? And so this session that we have with today, we are gonna take a road trip, a journey together from schedules b to our destination of an s corporation. Now you might have been thinking about taking this journey with your clients. Maybe they've come to you or you've been looking at at their financial situation that you think that might be a good advantage tax advantage to make them elect as corporation status. But like every road trip, we know that it takes time to prepare. We need to watch out for those wrong turns. We need to stay cautious of all of those caution signs along the road before we take that road trip. So for this session today, I will be your GPS. You're gonna be the driver. And on the passenger seat, that's your client, the self employed entrepreneur. Let's do this. Now let's first get to know what an s corporation is because we need to understand this road that we're gonna take. A corp an s corporation is an entity, a corporation, or an LLC that elects s corporation status. It does provide that limited liability that comes with the corporation and an LLC. It's a pass through, flow through entity that it passes down its corporate income, losses, deductions, credits through to its shareholders for tax purposes. Now how does it do this? It reports an eleven twenty s to the IRS. That's where it reports all of its income losses deductions, and it passes down that income deduction losses to its shareholder owners through a schedule k one. When we talk about pass through taxation, we know that the s corporation is not taxed at their level. They're not there's no such thing as them paying tax at the s corporation level. Instead, the shareholders report their portion of that income loss deductions credits on their own personal tax return, and that is where the tax gets paid. Now before we take on to this road trip, before we start our journey, we do need to identify who our passenger is and if they're qualified to come down on this journey with us. First, we need to understand this business owner, the sole proprietor that we have. Are they incorporated? Are they an LLC, or are they incorporation? Because a DBA doing business as a loan does not qualify. They're they have to be incorporated as a corp or as an LLC first before we can even continue and elect s corporation status. Now they have to be eligible first to become an s corporation, and here are what makes an entity eligible, a business eligible to become an s corporation. They have to be a domestic corporation, organized and formed here in The US. They have to have allowable shareholders that are owners of this entity of this business, which are individuals, either US citizens or residents. They have to be either a certain took the trust or estates. That is all that is permitted to become a shareholder of an s corporation. And you cannot not have more than 100 shareholders. Now if it comes to husband and wife, husband and wife do count as one shareholder, and they can only have one class of stock. Of course, they can have different voting rights, but one class of stock. And I'll go over why that's important and what that means. But when we talk about eligible shareholders, I said they have to be individuals, either US citizens or US residents. I do get this question a lot. What about if the taxpayer is an ITIN holder? Can they be a shareholder of an s corporation? Well, if we look at the internal revenue code, section seventy seven zero one b three does define substantial presence test, which really talks about any individual that is here long enough in The US has established substantial presence and, therefore, has to pay income tax now because they are considered a resident for federal tax purposes. However, we know that ITIN holders an ITIN really is just an identification number that is allowed to be eligible to pay tax. That is the identification number that the IRS looks at to collect the tax. Now it's not eligible to obtain a Social Security number. We know that. So, therefore, ITIN holders, we know that they are not authorized to seek employment with an ITIN. And we're gonna go further down into reasonable salary, reasonable compensation. But just have in mind an ITIN holder, yes. Technically, they can be a shareholder of an s corporation, but one of the requirements to be a shareholder of an s corporation, and if you're providing services, if you're working for that s corporation, you have to receive a reasonable salary, reasonable compensation through a w two. And so if we think about it, ITIN holders, they are not eligible to work. Now if we look at the one class of stock, well, what does that mean? It means that the pro rata distributions, any money that comes out of the s corporation has to be distributed to the shareholders in proportion to their ownership percentage. We cannot have one shareholder distributing or or getting more money out of the s corporation than than the other shareholder if it's not according to their ownership percentage. If it's a fifty fifty ownership in the s corporation, each of them better be getting fifty fifty out of the bank account. Polling question number two. Now you probably already saw a pop up. If you haven't, again, it's on the menu to the right hand side. There's a tab called poll. Polling question number two. Can a business that is solely a DBA, a doing business app, elect to become an s corporation? Yes or no. Go ahead and answer. It doesn't have to be the right answer. Give you a couple seconds as you search for that polling. Again, there is no submit button. Just select one of the answers, and the correct answer is no. They cannot be eligible for just a DBA. They have to be either a corporation or an LLC to become an s corporation. Okay. So now we have an eligible corporation. Right? Really quick. Domestic corporation, a individual shareholder that's a US citizen, US resident, or certain trust or estates, no more than a 100 shareholders, and there's only one class of stock. We're gonna start our engine and hit the road. We've come across this. Now do you recognize what this picture is? It's a toll. Right? We've come to our Ferry First toll booth. Now when it comes to a toll booth, you have to pay a toll to continue. So let's talk about what this is. Revenue internal revenue code section three fifty one. The three fifty one exchange is this. What really happens when you elect to become an s corporation, that LLC is transferring all of its assets, all of its liabilities over to the s corporation in exchange for stock. Now when that happens, what will you do to calculate what the basis in that stock is? Will you take the assets of that LLC minus the liability, that is the shareholders' basis in the stock of the s corporation. What about if it's the other way around, where this LLC, this entity, this corporation, owes more than what it has? There's more loans. There's more credit card debt than what's in the bank account where the liabilities are greater than the assets. This results in a taxable gain. And according to section three fifty seven c, the gain must be reported on the owner's individual tax return. There is no negative basis. We know that. So what is the basis of this stock? You take liabilities or sorry. You take assets minus liabilities, and if that provides a negative amount, there is no negative basis. The lowest it can be is zero. We have zero basis, and we have a taxable gain for any amount over. Now let's look at this through an example. We see here for Adam. He has he's the sole owner of ABC LLC, and he elects to become an s corporation. Well, the day that he's going to elect, we look at his balance sheet. We see that the assets are a total of 20,000, and the liabilities are 10,000. Assets minus liabilities, that's a $10,000 basis in the stock of the s corporation. No taxable gain. But if we look at this other example, Stacy, she's the owner the sole owner of x y z LLC. Let's look at her balance sheet right before we would like to become an s corporation. Well, the the assets, the total amount in checking and savings account is 7,000, but we have a company loan and we have a credit card on file. And the balances in total for liabilities is $14,000 more than the assets. So her basis and the s corporation stock once the election is made is zero. And we have a reportable taxable gain of $7,000 because liabilities are greater than assets. At that point, do we continue on this road trip? Do we really want to become an s corporation? Well, we can, but there's some things we have to do. Remember, this is a toll booth that we're at. The taxpayer can either contribute more capital to make those assets greater than the liabilities or pay down some debt so that liabilities are not greater than the assets or simply recognize the taxable gain and keep moving forward. Okay. Here's another tow booth. What about if the LLC, if the corporation, the entity, the business owns appreciating assets? Now here's an example of the most common appreciating assets. Real estate being probably the most common out of this list. Real estate, which is land or buildings, property, intellectual property, stock, artwork, high demand business equipment. Maybe there's a very specialized type of equipment that actually goes up and appreciates in value. These are appreciating assets, which most of the time, they're gonna appreciate in value. Now is it a good idea to become an s corporation when you have appreciating assets? Probably not. And this is the reason. Internal revenue code section three eleven. If you have a distribution of appreciating property back to the shareholder, it is not tax free. If the s corporation distributes this asset with the fair market value greater than the basis, then it's treated as if the s corporation had sold that asset at the fair market value the date of distribution, and there is a recognition of gain. That's why appreciating assets, as we know, once we contribute them into the s corporation at one amount, over the years, it's gonna keep going up. And the day that we decide to take those assets out, maybe change the deed on that house, change the, title on the building over to the shareholder, that is the day that it's deemed a sale at the fair market value of that day. So the gain, it passes down to the shareholder, and it is taxed at the shareholder level. Let's go over an example on this. In 2020, let's say Jack LLC, they bought a building for 500,000. A year later, Jack decides that they want to elect s corporation, and they do. At that date, the building basis is the 500,000. Well, four year or three years later, on 12/31/2024, the fair market value has appreciated. That building is now worth 800,000. At that date, let's assume that the basis the adjusted basis in the building after depreciation is 200,000. Now Jack wants to take that building back and put it under his name. Maybe they have more plans for this building. Maybe gift it to the son, other plans, but they want it out of the s corporation. Well, that is deemed a sale. It's treated as if the s corporation had sold the building at fair market value of 800,000, and now we have a gain on the books for 600,000, which is gonna be passed down to Jack, the sole shareholder of this s corporation. Jack now has a taxable gain to report of 600,000 even though there was never cash exchange. There was no closing documents. There was no actual sales documents. It is a deemed sale. Now also appreciating assets, they don't receive a step up in basis when the shareholder passes away. Now the stock that that shareholder owns does receive a step up in basis, but the assets within the s corporation do not receive the step up in basis, and therefore, there is a gain that is still trapped inside of the s corporation. And that's what happens. The shareholder cannot just easily take appreciating assets out of an s corporation without a recognition of gain, without triggering that gain. So restructuring and refinancing or moving assets out of the entity, it it is gonna cost money. There's a toll to pay. It's gonna be expensive. So do we continue on this road to become an s corporation if the entity owns appreciating assets? Well, let's bring awareness to the taxpayer because sometimes the taxpayer comes to us demanding to become an s corporation. We need to make them aware of the ramifications about the potential taxable gain if there's a distribution of of that asset, the limited step up in basis of that asset inside of the s corporation. And most likely, we're gonna advise them that it's not the best option to become an s corporation. There are other entity structures that we can do, but s corporation might not be the best option for them. Administrative responsibilities and cost. I think this is the one that surprises a lot of clients, a lot of taxpayer clients, is that, yes, there is some tax savings when you become an s corporation, but but it's gonna come with responsibilities and more fees. And there are professional fees, there's payroll costs, and there's also state tax for those, LLCs that are formed in certain states. So if we talk first about professional fees, right, we're charging already the client for a ten forty return for their schedule c. Now we're gonna have to prepare an eleven twenty s, and we are gonna charge for that extra. There's also bookkeeping and accounting services that have to now be provided. Either we're contracted to do those or they hire somebody else to do them, but books have to be in order for this business, for this s corporation. And then there's legal or advisory support to maintain the corporate formalities. Maybe in the future, there's an a shareholder that will enter the picture, an additional shareholder, or maybe the client is thinking about selling the stock and exiting the s corporation. There's gonna be some fees around this. It's not an easy entrance or exit without some formalities and legal advice to go into it. Now the payroll cost. We talked about reasonable salary. We're gonna go over reasonable salary a little bit more further on, but we know reasonable salary. A shareholder that is providing services to the s corporation, this business owner, has to receive a salary, a reasonable salary. So, yes, we need to set up and manage their payroll system, either us or it's outsourced to a payroll service. And it's not gonna be for free. We're gonna charge the payroll service will charge because now we have more tax filings. We have the ten four the nine forty, the 941, the w 2, w W3. Now I'm not even listing on here the state. Right? State also has their share of forms to file when it comes to payroll. State tax. That's another toll we have to pay, especially those states that do tax s corporations because some states, they treat s corporations just like c corporations, and they tax the entity at that level. Some of them do partially recognized as corporations, but still, they will charge a corporate level tax. And other states, they impose s corp level taxes and also the flow through income. The shareholder then gets taxed again. So he here are some, examples of two of the of the places that do charge a tax on s corporations. California. Is anybody from California? California imposes a franchise tax of 1.5% of the net income, but the minimum is $800 to pay. New York City, they impose a general corporate tax of 8.85%. Anybody here from New York City that are aware or have clients there, you know, there are some taxes to pay. Now if we look at an example, because this is the the most, talked about of why to become an s corporation because there's tax savings. Okay. So let's look at some tax savings. We see those two columns. For this example, we have schedule c at the very top, a 100,000 of net income. Okay? The salary, there is no such thing as salary distributions that we need to really worry about when it comes to a schedule c. First salary is not even not even permitted on their schedule c salary for the owner. So the the payroll the self employed tax on a 100,000 of self employment income, 14,130. The QBI deduction, we know 20% of the qualified business income, that's a $20,000 deduction, comes to about an income tax of $79.41. Total tax, if we take federal income tax plus the self employment tax, total tax for this taxpayer, 22,000. So let's look at the savings if we were to elect if you to become an s corporation. So we start off at the same, a $100,000 of net income, but then we pay a salary. 60,000 goes to the shareholder. The remaining 40,000 is net income that gets distributed down to the shareholder. So our payroll tax you see the difference here as as you see a savings. Right? It was 14,000 of self employment tax. Now we have payroll tax of $91.80. But then our QBI deduction goes down because now our really our qualified business income is the 40,000 of net income that flows down to us as a shareholder on that k one. That's $8,000 of the QBI deduction. So in total tax, total tax of 10,000 or federal income tax of $10,007.27 plus the payroll tax really is a grand total tax of about 19,000 let's say 20,000. That's a savings of $21.64. Okay. That seems pretty tempting. Right? We saved on tax 2,100. Let's look at the next slide, though. From that savings, remember, we have to now pay the prep fee for the October, the prep fee for the 11/20 s. Now you do see a comma in there, right, for the prep of the 11/20 s because, hopefully, we're charging an amount that involves a comma for an s corporation return. Then there's payroll return fees, and there's other fees which include bookkeeping fees, the state tax return fee. I didn't even consider the legal fees on here, but you can see that the savings of $21.64, is it really a savings compared to the cost for running an s corporation? Now I did include on this, slide, which you have access to the to the deck, the entire deck. On this slide, there's a link to an interactive calculator that we have where you can enter the net income. You can enter the reasonable salary and it gives you the tax savings. And not only does it give you a tax savings for an s corporation, but then it also gives you the end other entities, a c corp, a partnership, what it looks like per entity because maybe s corporation might not be the best, decision and the best choice of entity. So do we continue on this road to become an s corporation after we look at all the savings and tax, but we also consider the administrative responsibilities and the cost? We need to look at not only the current projected business income, but maybe the projected income in future years. Maybe this business is growing where $2,000 of the savings today might not mean much, but maybe next year, their income is gonna significantly increase where the savings will be a lot greater. Now the shareholder, our clients, are they willing to maintain the corporate formalities? Are they willing and aware of recognizing the payroll requirements now? And then what about their desire for a long term business growth and planning flexibility? Because, again, it comes with responsibilities to become an s corporation. Or is this a business that maybe they're just running on the side, not really thinking about it growing more? Then they're really gonna be stuck to a a tax savings, like in our example of 2,000, plus all of the cost that they have to pay. So is it worth it? It's a taxpayer by taxpayer basis. Okay. Now let's go into our exit, 315, and I put here Interstate 2553. Because we have our form twenty five fifty three, now that we've gone and paid all the toe toe boots, we we are an eligible entity to become an s corporation. We're aware of all these responsibilities and extra costs, and we want to continue to become an s corporation, we must file form twenty five fifty three. And that is the election, by a small business corporation to become an s corp. Now who files it? Here are the key requirements for this election to be valid. First, you must be an entity that is eligible. Remember, we talked about domestic corporation has to be a, individual, either US citizen, US resident, or it could be a trust or a state, not more than a 100 shareholders and one class of stock. And all shareholders of this s corporation must sign this consent statement. The shareholders who join after the election has been filed and approved do not have to go back and sign a twenty five fifty three. It really is only those shareholders that are owners the day that we are electing to become an s corporation. And then an officer, an authorized officer of the s corporation has to sign the 2553 as well. The corporation, they must provide their exact name, address, and required info. If we go back to the previous slide, we see that towards the very top. Right? That's the information that has to get turned in, the employer identification number, and then check out b and c. Not only do we have to state when we incorporated, when this entity became an LLC or a corporation, but then also the state that we incorporated. And then we have to elect on e, the date that we want to be treated as an s corporation. What day as of what day do we want to start s corporation status? Now when do we file? We do have a deadline for this. The fifteenth day of the third month that the election is to take into effect. For example, if we have a corporation that is a calendar year that they want to become an s corporation for the year 2025, and they want to be treated as an s corporation as of 01/01/2025, they only have no later than 03/15/2025 to file the form 2553. What about a new entity that formed on February 15? Well, if we start the time there, at fifteen days and three months from there, it would be April 29. Now do you know that you cannot start the s corporation status? You can't put on the twenty five fifty three that this entity in the second example, they want to be treated as an s corporation as of 01/01/2025 because they were not even in existence. The first day that they were in existence was February 15. And then if you want to become an s corporation the year after. So maybe we're in the year 2025, but you know what? Let's not start the s corporation until 01/01/2026. You can send the twenty five fifty three anytime now before 2026 even starts. But, again, you only have fifteen days and three months after 01/01/2026 to file the 2553. What about if we missed the exit? Right? We missed the election, the timely election within fifteen days and three months from the day we want to be treated as an s corporation. Well, there is release that is granted for a late election. And this is under revenue procedure 2013 dash '30. We must state a reasonable cause, though. Why were we late? Now I will tell you based on my experience with filing late election, reasonable causes, the IRS is really lenient on this. Not very lenient on reasonable causes for, penalty abatement, but reasonable cause for late election are very lenient. Especially, a reasonable cause would be that a taxpayer intended to be an s corporation. They paid themselves a reasonable salary. They presented themselves as an s corporation among the public. They just were not aware that there was an election twenty five fifty three that had to be filed. Now if we do have a tax free client like this, we still have time because this late election has to be filed within three years and seventy five days of when we were intending to be an s corporation. Now when you do file the 2553, at the very top of the form, and I will show you an example later on, we do have to have this text, filed pursuant to revenue procedure twenty thirteen dash 30. Also, if you are filing in a late election of, 2553 with the filing of the tax return, with the filing of the eleven twenty s, it's always a really good idea to, include the same text on page one of the eleven twenty s, and I'll show you an example. But most software providers do have this text. If you just check the box that's in the late election, the text will be printed at the top of both places, the eleven twenty s, page one, and the twenty five fifty three. So here's what it looks like. On the twenty five fifty three, this there's text at the very top. And then if this gets filed with the eleven twenty s, there's text at the very top as well. Okay. So we're traveling on this road. But if our destination if we are really in a place like this, a community property state, and we are electing to become an s corporation, there is an additional requirement that must be met. Because if you're in a community property state, there has to be spouse consent on the election. Because in community property states, both spouses have to sign the twenty five fifty three even if only one of them is the owner of this LLC, of the corporation that's electing to become an s corporation. Now if that is the case, we have to include the spouse's name on the twenty five fifty three where there's where all the shareholders get listed. That spouse must be listed on that form, and you can right next to their name, you can enter consenting spouse. And, of course, in the columns where we where we display the shareholder ownership, that spouse would be zero. They don't own the s corporation. They're just on the twenty five fifty three as a consenting spouse, and they have to sign and date the twenty five fifty three as well. Because we do have Treasury Regulation 1.1362 dash six, and the IRS instructions of the form twenty five fifty three do state that the failure to obtain spousal consent in one of these community properties can invalidate the s election. So make sure that we do remember that the business owner, yes, they might be the sole shareholder, the sole owner of the business. But if they are married and they live in a community property state, the spouse has to also sign the twenty five fifty three. Now once we mail out the twenty five fifty three, we electronically file it, fax it in. What's next? Well, usually, sixty days of a time, waiting period. We will, not as for the taxpayer. We need to make sure that the taxpayer knows this and keeps an eye in their mail that they will receive a CP two sixty one notice. The letter that either approves them or it rejects them, letting them know why they were rejected for s corporation status. So if we haven't heard back from our clients within sixty days, please reach out to them. They probably forgot about this notice and didn't really pay attention to the mail. But, I did recently file a late election, and I received an approval within forty five days. So it really all depends on the timing of when you send this out, but I wouldn't be surprised if it's under sixty days. If it's over within sixty days and still no approval, that's the time we gotta reach out, to the IRS and find out more. Okay. Polling question number three. Now remember I did say perform twenty five fifty three. First, you have to be an eligible entity to elect the s corporation status. So what is an s corporate what is an eligible entity? Is it being a domestic corporation? Is it that the shareholders are individuals, US citizens, US residents, certain trusts are in The States, and that there's not more than 100 shareholders, and that there's only one class of stock, or is it all of the above? Just go ahead and answer, the polling. Again, there's no submit button. And if you're not finding the polling, go to your menu on the right hand side where you see the chat and the q and a, and, go ahead and select your answer. No submit button. So let's go ahead and get credit for today's session. K. We're gonna move on to the next. Hopefully, you got, some time to answer that polling question. That was polling question number three. Okay. So the roads on the sign, caution road signs. Right? S corporation, we have compliance requirements. So we have submitted our s corporation status. Right? We we elected to become an s corporation. Now what? We need to maintain that and make sure that we're still eligible all the time, and we're following the rules and complying with these compliance requirements. So let's talk at the first one. You know, we talked a little bit over, in the prior slides about a reasonable salary. And, yes, reasonable salary is mandatory for s corporation shareholders that are owners. They're considered employees, especially if they're providing services. Now here in our example, in this road trip that we're taking, do you remember our passenger? They're the self employed entrepreneur. They're the entrepreneur. They're working for their business, so they need to get paid a reasonable salary. Now the requirement is, like I said, s corporations have to pay a reasonable salary for services that are rendered. And this salary, it's subject to payroll taxes. But the advantage is that anything above the salary, that profit after paying salary is not subject to employment taxes. So that is where the most of the tax savings come from. And that's why s corporations are very widely marketed, that it's a good choice because of tax advantages on payroll taxes or self employment taxes. But, again, remember, we went through our toll booth and remember those requirements on what it takes to become an s corporation. So what is reasonable salary? Unfortunately, the law does not give us a magic formula to calculate the reasonable salary amount. Instead, what we do have to do is determine it by facts and circumstances. There's common common methods, the market approach, the cost approach, and these are the IRS scrutiny factors. This is kind of like what they look at to see if the salary that the shareholder is receiving is reasonable or not. They're gonna look at the duties and the responsibilities of that shareholder, the time and the effort that are devoted to these duties and responsibilities, the experience and the qualification of that shareholder. You know, is there a specialized training to do what that shareholder is doing, the expertise that that shareholder now has, the amount of experience, and then comparable pay. What would that s corporation be paying? This is the question I ask my clients. What will your business pay somebody else to do all of the duties and responsibilities that you were doing? And then company performance. If they see that the shareholders receiving very low salary, but the profits and the distributions coming out of those bank accounts to the shareholders is really high, but the salary is not reasonable, that is what good takes us to our next slide, the audit risk. So if you don't pay a salary to the shareholder employee, that's a red flag. Why? Because there's no taxes being paid, no payroll tax being paid, no self self employment tax being paid. There has to be a reasonable salary. That shareholder shareholder employee has to get compensated for the work that they're putting in. Now what can happen if there is no no salary or very little salary? Well, the IRS can reclassify those distributions and apply or reclassify those distributions, the money that came out of those bank accounts to the shareholders, reclassify them as salary. And then guess what? They're gonna collect payroll taxes. Not only that, they're gonna collect some penalties and some interest. So it can be a really expensive thing to not provide a salary, not pay a salary, reasonable salary as best. And but then also when it comes to salary, the QBI deduction comes into play. And sometimes we kind of overlook this because salary does reduce that qualified business income. We saw it in the earlier example. Right? Now your net income comes down by the salary expense, leave us with less of a qualified business income to take that deduction. If you're under those income limits, it doesn't, it it results in a smaller QBI. What about if you're over the income limits? Well, maybe salary will help you. So let's look at an example. Here we see two columns. Right? The this married filing joint couple is above the income thresholds. So if we look at the QBI, qualified business income before any wages were paid 300,000. In our very first Example, the the column that you see where no wages were paid, we see that qualified business income after wages is the same, 300,000. There was no salary that was paid. 20% of that is 60,000. Qualified business income deduction, though, is zero. Why? Because it's they're over the income threshold, and it's the lower of 20 of the QBI, which is 60,000, or 50% of the w two wage limitation, which is zero in this case since they didn't pay themselves a wage. That beats it so that's well, I'll allow qualified business income deduction, zero. What about if they really did pay themselves a salary? Let's say they paid themselves a salary of 200,000. Yes. It comes with payroll cost, but you're fulfilling the requirement of reasonable salary. Now our QBI, the qualified income, after those wages that were paid on the last column we see is a 100,000. 20% of that is 20,000. That seems pretty good. But then we have to take you know, they're over the the, income threshold, which means the w two wage limit kicks in 50% of wages, a 100,000. The lower of the two is the 20,000. So, really, this grants you a qualified business income deduction versus the first example on the column, no wages paid, provided you with zero. Then another compliance, requirement, fringe benefits. Fringe benefits, they're allowed to be provided by the s corporation. Right? But when it comes to a shareholder that owns more than 2% of the s corporation in our example, we're just talking about that one sole shareholder entrepreneur. They own a 100%. So, yes, the s corporation can pay for health insurance. That's a fringe benefit. But that health insurance has to be provided on w two box one. Not subject to FICA, not on box three and five, but it does have to be on box one. The shareholder can then reduce their taxable income by applying the the shareholder self employed health insurance deduction on their personal return, but it does have to get reported on box one as taxable wages. Like I said, common examples is the health insurance. Now cafeteria plans, they're not allowed or they are allowed by the s corporation. But if a shareholder that owns more than 2% is a participant in the cafeteria plan, the entire cafeteria plan gets invalidated. Now the accountable plan. Now why am I bringing this up? Because we have this business owner that was a schedule c. Most likely, they're they're driving their, personal car for the business, so they have business mileage. Maybe they are using their home office. They have a home office deduction. Maybe they're using their personal cell phone, maybe 50% business, 50% personal. They have these expenses that they're paying out of pocket personally. When they were a schedule c, we just took those numbers. Right? We tell them to measure the office space at their home, give us their business mileage log, and we did the computation. Well, now when you're an s corporation, does the s corporation own that business car? Probably not. It's probably still under the the shareholder's personal name. Does the s corporation own the home where the home office is? I hope not. Right? We talked about appreciating assets. But so there are expenses that the shareholder is paying personally and needs to get reimbursed because they are using it for business. They're using their vehicle for business purposes. They're using their home for business purposes. So there here comes the accountable plan. They must get reimbursed through an accountable plan. Now there are some requirements that come with it. There are responsibilities that come with it because these are plans for s corporation owner employees. It's a plan to reimburse business expenses that are tax free, so they won't be taxable to the employee shareholder, but there are rules that must be met. The requirements, the expenses will have to have a business connection. There has to be timely receipts, timely reports, meaning mileage log, proof that the expense was spent, and timely reimbursement. You can't wait until the end of the year to get reimbursed for the entire year of your home office or your business mileage expenses. The s corporation gets a deduction for the home office for the business use of the the vehicle. They get a deduction at the s corporation level. The shareholder employee gets reimbursed tax free. So let's look at the timeline because timelines have to be respected for accountable plans to be validated so that that reimbursement is not taxable. I'll leave you here with a thirty days, sixty days, one hundred and twenty days. Thirty days, the employee needs to return any excess distributions. If they got reimbursed more than they were needed to, they have thirty days to give that money back to the s corporation. Sixty days, employee should account for those business expenses, provide the receipts, the mileage log. This is where the responsibilities come in that the shareholder employee, our taxpayer, our passenger needs to understand these responsibilities that come within s corporation. And then a hundred and twenty days, oh, is where you return the excess amount. So the key rule, if these timing rules are not met, like I said, those reimburse reimbursements do become taxable wages subject to income subject to income and, of course, payroll taxes. We talked a little bit about one class of stock. That is a requirement to become an s corporation and maintain s corporation. Now the distributions, liquidation, and proceeds, they have to respect the ownership percentage. Now when we have one shareholder, like in our example, when we started this road trip, we have only just that one social holder employee. It's not a problem. There's a 100% owner. But what about if we have more than one shareholder and we have different percentage amounts, or different percentages of ownership or maybe fifty fifty? Well, any money that comes out of the bank account has to be according to their percentage of ownership. Again, I've run into, new clients where they show me their balance sheet and the distributions for those two shareholders were not equal to their percentages. One shareholder was taking a lot more money because they're the ones who contributed a lot more capital when the s corporation was formed, And the other shareholder, even though they were fifty fifty, was providing more services than capital. But the one providing the capital at the beginning felt like they had the right to get more money out and not allow the other one to take money out. So that's where it comes into an issue because then it doesn't really become one class of stock, and that can invalidate the s corporation. Another compliance requirement, basis tracking. Now this is really important, and I think it does get missed a lot where we need to keep track of basis, not only the initial when the contribution was made. For example, at the very beginning of our session, we talked about assets minus liabilities. That is the initial basis of your stock, in the in the s corporation corporation. Well, every year, we need to make sure that we track that basis. We have to increase it with the income that flows through. We have to decrease it with losses that come through. And why is it so important for us to track basis? Because the pass through losses what about if one year the s corporation didn't do so well and they have a loss? Can the shareholder deduct that loss? Can they take that loss on their tax return? If they have enough basis, yes. They can. If they don't have basis and they're limited, they won't be able to take that loss. Also, the taxability of distributions is very, important, and I see it missed a lot. The where the client the shareholders going in and taking money out of the bank account of the business because they're probably used to when they were a schedule c. They were taking as much money as they wanted out of the bank account. Didn't really matter. Now with an s corporation, that money, if it's gonna come out, we better have enough basis so that distribution of money does not become a taxable event where they have to pay a capital tax on the distribution. And then the stock sale impact. Right? What happens if the shareholder wants to exit one day and wants to sell off the business? How are we gonna compute the either the gain or the loss on the sale of that stock? We need to know the basis. We've reached our destination. So this is just a reminder. If you have clients that are thinking about electing s corporation status or you've been thinking about taking your clients on this type of journey, just remember, being an s corporation filing for an s corporation is not just completing an eleven twenty s. Right? It's about leadership. It's about really thinking about those wrong turns, thinking about the responsibilities that come with it, and the taxable events that come with it if you have, for example, appreciating assets, if you have liabilities that are greater than assets when you become an s corporation. And so if your client comes to you that they want to be an s corporation, I just want you to remember that you are the driver, not the passenger. Thank you. With that, everyone, I'm gonna leave you with some resources that you can always access with our support in our community. Access those websites because this is where we provide resources for you. You will have, again, a survey at the end of the session. You're probably it's probably coming up anytime soon, but I do want you to make sure that you provide us your feedback so that we can shape our webinars with the information that is most useful to you. But, again, here's the the link for the resources in our training. I hope to see you in a future webinar, and everybody take care. Have a great day.