Costs of Goods Sold
Costs of goods sold always reduce the S corp's income for the year. S corporations can use either the LIFO or FIFO method of inventory. LIFO, short for last-in-first-out, considers the S corp to sell the most recently acquired inventory first. FIFO, or first-in-first-out, considers the S corp to sell the oldest inventory first. For example, if the company bought 10 pairs of shoes for $15 each in January and 20 pairs of shoes for $25 each in February, an S corp using LIFO that sells five pairs of shoes would have $125 in costs of goods sold. Conversely, a company using FIFO would have only $75 in costs of goods sold.
An S corp can also deduct the overhead costs such as rent and equipment. However, if the item is going to have a useful life of more than one year, you usually have to amortize the cost over the item's useful life, according to IRS regulations. For example, if the S corp purchases office furniture that has a useful life of 10 years for depreciation purposes, the S corp could deduct one-tenth of the cost each year.
The salaries and wages of employees can be deducted from the S corp income. This also includes any benefits the S corp pays for, such as retirement plan contributions made by the company. These include people who are only employed by the S corp but have no ownership interest as well as owners who also perform services for the S corp. Owners must receive a fair salary for their work and must treat that salary as earned income. However, the remainder can be treated as investment income.
Bad debts can be deducted, but only to the extent the money was already included in taxable income. For example, if an S corp makes a loan of $50,000 to a supplier and the supplier goes out of business before repaying the $50,000, the S corporation can deduct it. Similarly, if an S corp uses the accrual method and reports $10,000 of income on its taxes in one year because it has an account payable for the sale, but then the buyer goes bankrupt and never pays, the S corp can deduct the $10,000. However, if the S corp agrees to a sale of goods but then the buyer reneges and no transaction takes place, the S corp cannot claim a deduction for the lost sale.