How does S corporation tax return preparation work?
S corporation tax returns represent a both a big chunk of work as well as a big tax saving opportunity for small businesses. Accordingly, I want to talk briefly about what work you and your bookkeeper or accountant needs to do in order to prepare an S corporation tax return.
Because my CPA firm prepares both federal S corporation tax returns and state S corporation tax returns for businesses in most states, I also want to talk about the mechanics of becoming a tax return client of Stephen L. Nelson, CPA, PLLC. You might decide to have our firm to prepare your S corporation tax returns. And even if you choose some other CPA firm, understanding how one CPA firm works will mean you understand how the process often works.
Typical S Corporation Tax Returns Required
As compared to a sole proprietorship or a one member limited liability company operating as a sole proprietorship for tax purposes, an S corporation requires quite bit of additional tax accounting.
The first bit of tax accounting required for an S corporation is payroll accounting for the corporation's employees. As a general rule, an active S corporation must pay its employee a reasonable wage. This requirement remains true even when the S corporation has a single employee who happens to be sole shareholder of the corporation.
At a federal level, payroll accounting requires an S corporation to file quarterly 941 payroll tax returns which report on the wages paid to employees, the Social Security and Medicare taxes that the employer owes on those wages, and the taxes withheld from the employee's gross wages for federal income taxes, Social Security taxes, and Medicare taxes. S corporation payroll accounting also requires the filing of an annual 940 payroll tax return to report and pay federal unemployment tax (also known by the acronym FUTA). Finally, S corporation payroll requires the preparation and distribution of W-2 and W-3 forms which report to employees, the Social Security Administration, and (indirectly) to the Internal Revenue Service what wages and taxes an employer has paid over the year.
You can get forms and instructions for all of these payroll accounting tasks from the Internal Revenue Service web site, www.irs.gov. You can also often get forms and sometimes instructions from the local office supplies store and from your accounting software provider (such as the Intuit QuickBooks folks).
Bookkeeping Preparation for an S Corporation Tax Return
If an S corporation generates revenues of less than $250,000 a year and owns total assets of less than $250,000, the only real bookkeeping work required in order to prepare an S corp is the generation of a simple "profit-and-loss" statement.
If you're using an accounting program such as Quicken, Microsoft Money, QuickBooks and so on, you can probably prepare the profit and loss statement by clicking a menu command. The command will usually be entitled something like "profit-and-loss statement" or "income statement."
A couple of tips, however, about generating this profit and loss statement should be made. Be sure to reconcile your bank accounts before you produce the profit and loss statement (This reconciliation will quite possibly catch and correct any bookkeeping errors you have made over the year.) Also, be sure to tell the tax return preparer about any expenditures that don't appear on your profit and loss statement. For example, if you purchased assets that need to be depreciated and those assets don't appear on the income statement.
If you aren't using an accounting program (and some small-service businesses can get by with a shoebox-style accounting system), you can use an Excel workbook like the Example S Corporation Profit-and-Loss Statement. It shows how a profit and loss statement looks if a client has the following transactions:
- Receipt of $100,000 of consulting revenue
- Payment of $40,000 in shareholder-employee wages
- Payment of $3493 in associated payroll taxes
- Payments to Staples totaling $5000 over the year for office supplies
- Payments to the CPA for tax accounting services over the year for $2000
- Purchase of a laptop computer (which cost $3000)
- Payment of the client's personal car loan ($5000)
- Payment of $40,000 of dividends to owner
I intentionally created more expense lines in the workbook that my simple example uses, however. I did this so you can use this workbook as a template for constructing your own profit and loss statement.
A handful of quick tips about "preparing a profit and loss statement" using an Excel worksheet:
Tip #1: While you might be tempted to create all sorts of business-specific or industry-specific expense categories, try to combine these specific-to-your-situation terms into a logical, traditional category like one of those shown in the example profit and loss statement template. Water, sewer, gas and garbage might all be grouped together as "utilities", for example.
Tip #2: Remember that only ordinary and necessary expenditures are valid business deductions. Accordingly, if you have a question about the deductibility of some expense, be sure to do some research or ask your tax advisor.
Do-it-yourself S Corporation Tax Return Preparation
You can download the 1120S form and the form's instructions from the Internal Revenue Service web site. In all cases that I'm aware of, you can also download the equivalent state S corporation tax form and instructions from the state revenue agency's web site.
I think it's a mistake to try preparing your own S corporation tax return. If you're really getting benefits from operating as an S corporation, a good CPA or enrolled agent who understands S corporation tax law and who keeps abreast of new developments in S corporation tax law and IRS administration of S corporation tax law should save you some multiple of what the CPA costs you.
For example, a good CPA or enrolled agent should be able to help you set a low but still reasonable salary. A good CPA or enrolled agent should also be able to identify and exploit S corporation tax saving opportunities such as a SEP-IRA pension plan or a Sec. 105(b) healthcare reimbursement arrangement.
All that said, if you don't want to use professional tax practitioner, I suggest you purchase and then use one of the business tax preparation packages for consumers such as TurboTax for Business. You should not attempt to prepare the S corporation tax return by hand. The return is too complicated.
A final tip: If part of the reason that you feel like a CPA doesn't make sense is because a CPA-prepared tax return is too expensive given your S corporation profits, you quite likely shouldn't be an S corporation. You should probably be a limited liability company that's taxed as a sole proprietorship.
Having a CPA Prepare Your S Corporation Return
If you want a CPA to prepare your S corporation tax return, you typically need to finish up your bookkeeping for the year (as described earlier) and then supply the CPA with a profit-and-loss statement.
If you want us to do the S corporation tax return, by the way, we strongly prefer to get a copy of the accounting software's data file (if you're using Quicken or QuickBooks) or a spreadsheet version of the profit and loss statement (if you're using any other accounting software program.) We also need the previous year's S corporation tax return (if there is a previous year) or the IRS S election acceptance letter and a list of the shareholders, their names, addresses and social security numbers, and their share percentages (if the S corporation is new).
Almost all CPA firms also require a signed engagement letter that spells out the exact work the CPA will perform, and that may specify or estimate the price for the work. (Our firm's standard engagement letter is available online. The engagement letter doesn't include prices because these vary by client. But our web site does include a page that gives standard S corporation tax return preparation costs.)
Three final notes about having a CPA prepare your S corporation tax return:
1. S corporation tax returns are typically due on March 15th and not on April 15th. Accordingly, S corporation shareholders should attempt to get their profit and loss statements and related information to a tax preparer in January. (Note: You can extend an S corporation tax return's deadline by filing a 7004 form with the Internal Revenue Service. Many states automatically accept the federal extension, but some don't so check.)
2. If an S corporation's revenues or total assets exceed $250,000, the S corporation tax return needs to include balance sheets at the beginning and end of the year. The balance sheet requirement means that you need to use a formal accounting software program (like QuickBooks, Peachtree Accounting, or Microsoft Small Business Accounting) and give the accounting data file to the CPA. Furthermore, the balance sheet requirement means you usually need to do a bit of additional bookkeeping in order to make sure that the ending balance sheet included with last year's S corporation tax return matches the starting balance sheet included with this year's S corporation tax return. You can have a trained bookkeeper do this, or you can pay the CPA extra money to do this as part of the S corporation tax return preparation. However, predictably, if you ask the CPA to perform this extra work, you either need to get the accounting information to the CPA early or you need to accept having your S corporation tax return extended and filing sometime after April 15th.
3. Remember that the income taxes on the S corporation's profits are actually paid on the shareholders' individual 1040 tax returns. Accordingly, you usually want the same person to prepare both the S corporation tax return and the shareholder individual income tax returns. In this way, the tax preparer can make decisions when preparing the S corporation tax return that minimize the tax paid on the individual income tax returns. (This consideration of the individual income tax returns that an S corporation tax return will affect is one of the reasons that a knowledgeable tax practitioner can save you more taxes than you can by using, say, TurboTax.) Back to list of frequently asked questions
Additional Information You May Find Useful
If you want additional information about how to maximize the tax savings related to running a business or investment venture, you may also be interested in one of my downloadable e-books (see descriptions below). Each book covers a category of tax planning topics that easily save a business owner significant amounts of income or self-employment taxes (potentially thousands of dollars a year) and is instantly downloadable.
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