Personal Income Taxation Question

Constructive dividends are illegal, btw.

The rules for expensing a part of your home are very specific and can be a major red flag for the IRS.

Can we get an example?

You start off with X amount in income. Excluding the obvious things like standard deduction, obvious business deductions, etc., is your tax bill somewhat close to X still, or are you able to expense "creative" things through your S Corp. that get your tax bill down to some much lower figure Y?

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so he won't pay tax with respect to that by his S-corp, but he will still pay personal taxes.

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I thought 100% of all profits by an S-corp are passed along to the individual and thus the S-corp itself pays zero income taxes.

At least that is how the accounting firm which does the K-1 reporting for an S-corp I own stock in treats the S-corp's income.

S-corporation earnings will not be treated as self-employment income if all shareholder employees are paid a reasonable salary. The question becomes what is a reasonable salary? In my experience the IRS has never challenged 30% of S-corp earnings. Using your example the S-corp would pay the doctor $90k in salary that would be subject to Social Security and Medicare withholding. Factoring in the employer's portion of those payroll taxes, the S-corp would be able to deduct $96,750 of expenses from the $300K of earnings leaving $203,250 of income that would be subject to income tax, but not self-employment tax. Assuming the doctor paid a flat 25% tax on his $90,000 of salary and $203,250 of S-Corp income, his total income tax would be $73,314 plus $13,500 of Social Security and Medicare taxes for a total tax of $86,814. If the doctor was a sole proprietor, then he would have had $110K taxed at an approximately 15% self-employment tax rate and the remaining $190K taxed at a 2.9% Medicare tax rate. The total self-employment tax would be $16,500. Then he would have $300K less $8,250 (50% of self-employment tax), or $291,750 taxed at 25% for $72,938 of income tax. His total tax would be $89,438. So having the S=Corp could save the doctor $2,624 of tax.

The doctor could deduct the same business expenses as either an S-Corp or a sole proprietorship. So he would end up with same net income from the medical practice in either event. The savings from avoiding self-employment income is an annual one, and it is permanent.

If you could justify a smaller salary for the doctor, then the savings would be even larger every year. If your salary is equal to or greater than the Social Security maximum then you are only avoiding the 2.9% Medicare tax. But 2.9% of six figures is nothing to sneeze at.

I could see working some jobs and being okay with 100k taxation on 300k salary. I could even see working some doctor jobs and being okay with it.

But the stress level associated with certain types of doctor jobs, like ER, for example, just does not warrant subjecting yourself to that kind of income tax burden. At some point the stress:taxation ratio becomes way too high.

It seems like most of our S corp clients put their real estate into a separate entity and pay rent to it. I have no idea if that a truly bankruptcy-remote setup (for either corp for that matter). I know it "kind-of" worked when GGP blew up in 08 or 09. It just seems like one of those "substance over form" things to me.

Great. Thanks for the insight Poodle, as always.

You have to be real careful with respect to using debt for basis in an S-Corp. If the S-Corp is the borrower, then the shareholders will not get basis for the debt even if they personally guarantee the debt. It is better for the shareholders to borrow money as individuals and then lend the money to the S-Corp. This will give them basis for the loan.

And to clarify on the 'personal loans' to increase debt basis, one stockholder can NOT borrow from another and then put these proceeds into the corp and obtain debt basis.

Now we are getting into the crevices of the code.

:)