To reduce the amount of income shareholders have to report, S corporations can take tax deductions before issuing Form K-1s. S corporations can fully deduct most business expenses, like salaries, business expenses and professional fees. However, there are limitations on meals and entertainment as well as health insurance deductions. Certain expenses must be capitalized and deducted over a few years.
S Corporation Taxation Basics
S corporations are pass-through entities, which means all earnings are passed through to shareholders. During tax season, an S corporation completes a tax return, complete with income, deductions and credits, to arrive at taxable income or loss. This income or loss is then distributed to shareholders on a prorated basis through Form K-1. Shareholders report this income when filing individual tax returns. Depending on the type of business the S corporation runs and the shareholder's basis in the S corporation, he may be able to use an S corporation loss to offset personal income.
For the most part, S corporations can make the same deductions as any other type of business. Typical business expenses, like professional services, marketing, travel, education, taxes, office supplies and interest expense, are all deductible. If the S corporation is owed debts it's been unable to collect, it can write them off as a bad debt expense deduction. The S corporation can deduct the cost of business meals and entertainment, but the deduction can only be 50 percent of the total cost.
Salaries and Health Insurance
The salaries of both employees and shareholders are a deductible expense. The cost of most employee health insurance is also deductible. However, there's an exception for health insurance purchased for shareholders that own more than 2 percent of the company. The S corporation cannot deduct these health insurance premiums. To make up for this, the shareholder can take a deduction on his personal return for the cost of self-employed health insurance.
Start-up Costs and Assets
Some expenses, like the costs you incur before the S corporation opens its doors, software purchases and other asset purchases, have to be capitalized. That means that the S corporation's tax deduction for these items will be spread over the life of the asset. The Internal Revenues Service requires businesses to amortize start-up costs over five years and software purchases over 36 months. It maintains a chart that indicates the useful life that should be used for other assets, like office equipment and buildings. To get a larger initial deduction, the S corporation can use an accelerated depreciation method, like the modified accelerated cost recovery system, to depreciate the asset.
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