S Corporation Deductible Expenses

Trying to figure out which expenses you can pass through your S Corp? The good news is that many expenses qualify, as long as they serve a business purpose (you know, the “ordinary and necessary” rule the IRS loves to mention). Keep reading to get the basics of how expenses can be deducted.

As you probably already know, S Corps are pass through entities and they pass their tax activity onto their shareholders via K-1 forms. The S Corp issues the K-1 form and the shareholder enters it on in their 4010 form. That easy! In their turn, shareholders can then use these expenses to reduce their taxable income on their 1040 form.

What Are S Corporation Deductible Expenses?

Here are some common business expenses that an S Corporation can deduct:

1. Salaries and Wages:

   • When an S Corporation pays employees, including the owners who work for the company, the salaries and wages are deductible. This helps lower the taxable income. You can read up on this topic here

2. Employee Benefits:

   • If the business provides health insurance or other benefits like retirement plans, these costs are deductible. The process is somewhat convoluted and you can read up about technicalities here.

3. Rent:

   • If the business rents office space or other property, it can deduct the rent payments.

4. Office Supplies:

   • Everyday office supplies, like paper, pens, computers, and furniture, are deductible.

5. Business Travel:

   • If the business owner or employees travel for work, the cost of airfare, hotels, and meals can be deducted.

6. Utilities:

   • Bills for things like electricity, water, and internet for business use are deductible.

7. Advertising and Marketing:

   • Any money spent on advertising the business, such as online ads, TV commercials, or flyers, can be deducted.

8. Professional Fees:

   • Fees paid to lawyers, accountants, and consultants are also deductible.

9. Insurance:

   • Business insurance costs are deductible, including things like general liability insurance and workers’ compensation.

10. Interest on Loans:

    • If the business has a loan, the interest it pays is deductible.

11. Bad Debts:

    • If customers owe money and the business can’t collect it, those bad debts may be deducted.

12. Reimbursements Through Accountable Plans: An accountable plan is a reimbursement arrangement that allows an S corporation to reimburse employees for business-related expenses, like travel or use of home. These reimbursements are not taxable for employees, as long as the expenses are properly documented and meet IRS guidelines. The corporation can deduct these expenses as business costs. You are welcome to read up more on this topic here

    
    

These are just some of the most common S Corporation expenses that can be deducted. When it comes to S Corp K-1s (yes, we’re diving into some tax technicalities here), business expenses can be reflected on form K-1 in two ways: either as separate items listed on the K-1 or as a combined (lumped together) amount.

Separately Stated S Corporation Expenses

While some expenses are simply added up and deducted as a group, other expenses have to be reported separately. These are called separately stated items, and they include things that are treated differently for tax purposes.

For example, the money the business makes from selling property might be taxed differently than regular income. These types of expenses and income are passed to the shareholders separately, meaning each shareholder has to report them individually on their own tax returns.

Common Separately Stated Expenses

1. Capital Losses:

   • If the business sells something like a building or piece of equipment and makes a profit, that’s called a capital gain. Capital gains are taxed differently than regular income, so they must be reported separately.

2. Interest Expense:

   • If the S corporation has loans for investments, the interest can be deducted, but the deduction is limited to the net investment income, which includes income from investments like property gains or income from a business where the shareholder isn’t actively involved. When shareholder enters this expense on their 1040 form, they need to decide where exactly on shows up on their personal return and what part of it is deducted.

3. Rental Losses:

   • If the business owns property and rents it out, the rental income and any expenses related to renting it out must be reported separately.

4. Section 179 Deductions:

   • When the business buys something big, like new equipment or furniture, it can deduct the cost right away under something called Section 179. This deduction is reported separately.

5. Charitable Contributions:

   • If the business donates money to a charity, it can deduct the contribution. However, the deduction limit depends on the shareholders' income and whether they itemize their deductions and this information needs to be entered separately by the shareholder.

     
     

Why Separately Stated Expenses Are Important?

If the expense is not part of an owner's share of normal business income but will still affect the owner's individual tax return, it is likely a separately stated item. For example, the capital gains tax rate is usually lower than the regular income tax rate, so it’s important for shareholders to report capital losses separately to make sure they correctly offset capital gains from other sources.

Aggregated S Corporation Business Expenses

In many cases, S corporation deductible expenses are passed through as aggregated (lumped together) amounts. These are reported in one sum and are not broken down by specific category. Shareholders don’t need to worry about the details. Common aggregated items include:

• Business Expenses: These are costs related to the daily operation of the business, like office supplies, business travel, rent, marketing, supplies and etc. Please note, not all expenses can be deducted. For example, entertainment costs like tickets to sporting events are not deductible.  Percentage of deductible meals also varies from year to year.

• Fringe Benefits: These are additional benefits an S corporation provides to its employees, like health insurance or retirement benefits. These are deductible for the corporation but are not taxed for employees. You can read more about them here.

• Hobby Losses: If the S corporation is not engaged in a profit-making business, there may be limits on deductions. However, this can be avoided if the corporation earns a profit in three out of five consecutive years.

• Losses on Shareholder Transactions: If the S corporation loses money from selling property to a related party (like a shareholder), that loss cannot be deducted. A related party includes any shareholder who owns more than 50% of the company or a trust related to the corporation.

• Organizational Expenses: These are expenses related to starting the S corporation, like legal and accounting fees. The first $5,000 in expenses can be deducted in the first year, and the rest is spread out over time via amortization.

• Start-Up Expenses: These are the costs of starting the business, like advertising, training, and legal fees. Up to $10,000 of start-up expenses can be deducted in the first year, with the rest being spread out over several years.

• Nonbusiness Bad Debts: These are debts that are not related to the business, such as an employee defaulting on a loan. These bad debts must be reported as short-term capital losses.

  
  

Why Aggregated Expenses Are Important?

Aggregating business expenses helps the business simplify its taxes. Instead of dealing with each expense individually, it can group similar costs together and handle them as a single deduction. This helps tax preparation super easy!

In Summary

To summarize, S corporation deductible expenses can be passed to shareholders in two ways: separately or aggregated. When passed separately, each expense is reported individually on Schedule K-1 and must be listed on each shareholder's tax return. When aggregated, the expenses are reported in total on Form 1120S and then passed through to shareholders.

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