S-Corporation Tax Write Offs for Losses

By Jeff Clements

An S corporation is a small corporation that meets certain criteria and has made an election with the IRS to be treated as a disregarded entity for tax purposes. Instead of paying taxes at the corporate level, the S corp's losses and profits are passed through to shareholders, who pay the taxes. This has various tax advantages for owners, whether the company has a profitable tax year or shows a loss on its corporate tax return.

An S corporation is a small corporation that meets certain criteria and has made an election with the IRS to be treated as a disregarded entity for tax purposes. Instead of paying taxes at the corporate level, the S corp's losses and profits are passed through to shareholders, who pay the taxes. This has various tax advantages for owners, whether the company has a profitable tax year or shows a loss on its corporate tax return.

Pass Through Status

When a corporation elects to be treated as an S corporation by the IRS, the shareholders are choosing not to be taxed at the corporate level. Instead, the corporation passes its respective profits and losses through to its shareholders. This has net economic advantages of avoiding double taxation of earnings and profits, and in the case of losses, allows owners to shelter other sources of income from taxation.

Ready to incorporate your business? Get Started Now

Corporate Tax Return

An S corporation files an information return using IRS Form 1120S, on which it calculates profits or net operating loss on its business activities. The corporate tax return includes standard tax deductions for ordinary and necessary business expenses. However, since an S corp is a pass through entity for tax purposes, it does not pay any taxes on its profits or make use of losses directly. These are instead ratably allocated among the various corporate shareholders and disclosed to each on IRS Schedule K-1, so that each individual taxpayer may include the corporate profit or loss on their individual tax return.

S Corporation Shareholders

Each individual shareholder in an S Corporation receives an IRS Schedule K-1, which indicates the shareholder's percentage allocation of business profits and losses. Income allocated on the K-1 is combined with other sources of income on the shareholder's individual tax return. Any losses from the K-1 can then be applied against these multiple sources of income, potentially lowering the shareholder's overall tax obligation.

Carry Forward and Carry Back Losses

A valuable characteristic of pass though losses is that, according to the IRS carry forward and carry back rules, an S corporation shareholder may apply excess losses from the current year against previous or future years of taxable income. This advantageous tax treatment has the effect of increasing the value of deductions and losses since they can have significant tax effects outside of the current tax year.

Ready to incorporate your business? Get Started Now
Tax Consequences of Converting a C-Corp to an S-Corp

References

Resources

Related articles

How Is Passive Income Taxable to an S Corporation Shareholder?

A chief benefit of being an S Corporation is that it allows the corporation’s shareholders to be taxed directly on all income earned by the business. Owners benefit from direct taxation because a C Corporation's profits are taxed twice: once when earned by the corporation and again when distributed to the owners as a dividend. When an S Corp shareholder pays taxes on the business’s income, the funds are broken down based on how the S Corp earned the money. As a result, a shareholder may pay different tax rates on different portions of her S Corporation’s income. One aspect of S Corporate income that may be taxed differently is the business’s passive income.

Basics of an S Corporation

To gain the protection of limited liability, many businesses incorporate. However, this subjects the profits to two layers of taxation: the corporate tax on company earnings and the personal income tax on distributions. To take advantage of the more favorable pass-through tax treatment, corporations that meet certain requirements can elect to become an S corporation.

How to Prepare a Final K-1 for an S Corp

An S corporation is a special type of corporation that has elected to be taxed as a pass-through entity. Instead of paying income taxes itself, an S corporation passes profits and losses through to its shareholders. The shareholders pay taxes at the individual rate on their proportionate share of profits and losses by recording the amount on their personal income tax returns. Every year, an S corporation files an information tax return with the IRS, reporting the financial status of the company. Part of the information return is the preparation of Schedule K-1, which details each shareholder's pro-rated share of income or loss from the company. The S corporation sends each shareholder his copy of the K-1 annually, so the shareholder can use it to prepare his personal income tax return. When an S corporation goes out of business, or when it terminates its special tax election, it must prepare a final tax return and a K-1 that details the final allocation of profits and losses to shareholders under this method of accounting.

LLCs, Corporations, Patents, Attorney Help

Related articles

Can a Chapter C Corporation Carry Over to a Personal Tax Return?

Once you file the appropriate documentation to create a legal corporation in your jurisdiction, state and federal law ...

How an LLC Claims Profit and Losses

A limited liability company, or LLC, is a business entity type that has a history in the United States that spans ...

What Forms Do I Need to File for an S Corp?

An incorporated business is automatically designated by the Internal Revenue Service as a C corporation for income tax ...

Can You File an LLC With Personal Taxes?

The Internal Revenue Service has yet to create a tax return for LLCs. The income and loss that a LLC generates is ...

Browse by category