Limitations on S-Corporation Losses and Deductions

Generally, S-corporations are not subject to income taxes.  Rather, the income and/or losses incurred each year are passed-through to the S-Corporation’s shareholder(s) on a pro rata basis, and reported on the shareholder(s) Individual Income Tax return.  One tax matter to keep in mind for S-Corporation shareholders is the possible limitations on deductibility of corporate losses flowing-through to the individual.  We will discuss some of the potential issues that may limit the amount of deductible losses.

Compensation of S-Corporation Shareholders

One benefit of S-corporations over other entity types is the employment tax advantages that may be derived when shareholders receive a portion of the profits in the form of a distribution (dividends) rather than as compensation.  The origin of this benefit began with Revenue Ruling 59-221, which stated that a shareholder’s share of undistributed taxable income does not constitute net earnings from self-employment.

Business Bad Debts

If your business involves selling products or services to customers on short-term credit, you have no doubt had to deal with some of them not paying you.  Reviewing your accounts receivable may reveal long overdue balances that are likely to never be collected.  You may have relief in the form of a bad debt deduction.

Tax Aspects of Fines and Penalties

Taxpayers engaged in a trade or business may not deduct “a fine or similar penalty” incurred in the conduct of that business and payable to a government entity for a violation of law.  However, taxpayers engaged in a trade or business can deduct a “compensatory payment,” even if it is paid in conjunction with a fine.  Thus, it is important to distinguish between the two types of payments.

Health Savings Accounts

With health care costs continually rising, a health savings account (HSA) may be very beneficial for both your business and your employees.  HSAs are becoming increasingly popular for that reason.  Eligible individuals have the option of setting up an HSA through a qualified HSA trustee, and employers have the option of implementing such health plans that allow for an HSA.  An HSA is a custodial account that allows individuals to contribute pre-tax dollars and use those funds for qualified medical expenses for that individual, his or her spouse, or dependents.  The employer also has the opt


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