@JimClarkCPA Where did I say that they did not claim Section 179? That’s just a red herring you dragged across the thread to cover the odor of your initial failure to understand the problem. So let’s walk through the facts, very slowly, so even a CPA can understand them.

1) Taxpayers start a new business. With rented equipment, they can make an annual profit of $50,000. As revenue grows, so does the amount needed for operating capital. Employees are hired and paid before customers pay for completed work.

2) Taxpayers realize that they can increase profits if they buy the equipment, rather than lease it. So they find a deal for $50,000.

3) At end of year they have $100,000 profit – half in the bank because they need that much to stay in business, and half in the equipment they bought.

4) Schedule K-1 shows a $50,000 profit ($100K less $50K Section 179 deduction). A C corporation would have paid $7,500 tax on this. However, as owners of an S corporation they pay more than $15,000 in federal tax on the same amount.

As it turned out, there was a downturn in their business and a loss the following year. With a C corporation, this could have been carried back to wipe out the $7,500 liability. Even had profits continued, IRS would have had fewer ways to immediately collect the initial balance due.