C-Corp - No Payroll - Just Withdrawals and Personal Expenses

Technical topics regarding tax preparation.
#1
AlexCPA  
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Hello all,

A new client formed a C-corporation in the middle of 2017 (there is only one shareholder). There are no financials --just bank statements. After working through these statements, I found what looks to be $100,000 in income, $30,000 in personal expenses, $60,000 in withdrawals, and about $10,000 in what appear to be actual business expenses. The question is how to approach this situation with regard to the Form 1120 for tax year 2017.

My understanding is that there are two ways for owners of a C-corp to receive funds from the corporation -- wages and dividends. As no payroll was done for this corporation, I welcome any ideas which will result in a client who is both happy AND tax compliant -- does such a thing exist?! :)

The first option, of course, is to classify at least some of the withdrawals and personal expenses as payroll, in which case they would need to file late payroll documents and deal with the applicable penalties. In this scenario, any insights as to what the client can expect in terms of penalties would be extremely helpful. As the client's spouse provided administrative services to the corporation throughout the year, the corporation would file a (late) Form 1099-MISC for the spouse for tax year 2017.

The second option would be to classify the entire amount of the personal expenses and withdrawals as dividends, which would have the unfortunate result of double taxation.

The third option would be to classify some or all of the personal expenses and amounts distributed as shareholder loans. However, as the client never planned on paying any of these amounts back to the corporation, this treatment doesn't seem to hold water.

I am curious as to which approach (or combination thereof) you would recommend and why. Your help is much appreciated!
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#2
JR1  
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I'd likely opt for a 1099 one time only and pray you don't get picked. 'cuz in a C corp, unlike an S which he should probably be, ah well...the IRS has a huge incentive to disallow the late 1099 in favor of double tax. Spin the wheel and takes your chances.
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#3
AlexCPA  
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Thank you for your response. Would a late S-Corp election help in this regard? Even though the 2017 Form 1120S will be filed late, it may reduce the incentive to disallow the 1099 in favor of the double tax.

This is a service business which would otherwise qualify to be classified as an S-corporation. Thoughts?
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#4
JR1  
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My thoughts is that perhaps your client doesn't deserve to be rescued! lol I'm a bit fussy about those late elections. THey're meant for those who intended to be an S. I suspect your client is just an idiot and clueless...but it is a way out. You're his hero.
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#5
sjrcpa  
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AlexCPA wrote:This is a service business

Personal service with a flat tax rate for 2017?
 

#6
CathysTaxes  
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It doesn't sound like the client operated a corporation, more like a sole proprietor. I would recommend closing the corporation and file on Schedule C. IME, the majority of these types of clients are to set in their ways to deal with them as a corporation.
Cathy
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#7
JR1  
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I like Cathy's idea...if he didn't operate as a corp. Did he open a new bank account, issue invoices with Inc. on them, etc?
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#8
AlexCPA  
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Thank you all for your responses and insights! The client formed the corporation and opened a bank account in its name. Accordingly, I'm guessing that income checks were made out to the corporation as they were deposited in that account (which was then used to pay personal expenses).

At this point, I'm leaning towards making the late S-Corp election for tax year 2017 (the initial year) and filing Form 1120S along with Forms 1099-MISC (one to each spouse) to reflect the withdrawals and personal expenses on Schedule C. For tax year 2018, however (since the client has repeated the same pattern this year), my plan is to have them file late payroll so that the S-Corp distributions and wages will be properly allocated for tax year 2018 (and unfortunately deal with the resulting penalties as they come). Thoughts?
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#9
JR1  
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No such thing as a late payroll this year. You can cut a bonus 12/31, it counts for all year.
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#10
mscash  
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If the return was audited I think you could count of payroll tax deficiencies.
 

#11
JR1  
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I disagree as to this year, anyway. Nothing says when payroll has to be paid. Just that it has to be paid. Of course, next year he'll be filing every quarter...
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#12
Doug M  
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sjrcpa asked

Personal service with a flat tax rate for 2017?


What type of service business is this?

I am not up on the automatic approvals for late S elections, but I thought you had to file a timely S return. Do you think going the S route alleviates the no payroll issue?
 

#13
JR1  
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It doesn't alleviate, it just changes it. As a C corp, high risk of the non-payroll 1099 being turned back to 0, forcing double tax immediately. As an S, only the risk of PR penalties if enforced....pick your poison.
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#14
AlexCPA  
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Thank you all again for your insights and feedback! This forum really is a beautiful thing.

As for the late S-corporation election, unfortunately I believe that is no longer an option. Per review of Rev. Proc. 2013-30, I noted the following requirement:

"(5)(i) The Requesting Entity timely filed all required federal tax returns and
information returns consistent with its requested classification as an S corporation
for all
of the years the entity intended to be an S corporation and no inconsistent tax or
information returns have been filed by or with respect to the entity during any of the
taxable years..."

Accordingly, as we are now on 9/21/2018, that ship has sailed for tax year 2017. Additionally, the extension filed by the client was for Form 1120 which doesn't help matters. With the late S-corp election idea no longer being an option, the only ideas I have at this point are as follows:

File the Form 1120 and deduct as salary (without withholdings) the amount representing reasonable compensation for the sole shareholder with the remaining amount classified as dividends. The client would file the delinquent Forms W-2, W-3, 940, and 941 for the year and deal with the consequences pertaining to the late payment and filing of the pertinent payroll documents.

Shareholder loans don't seem to be applicable in this case as there was no formal documentation of such a loan. Furthermore, no principal or interest payments were made on this "loan" in either tax year.

For tax year 2018, since we are 3/4 done with the year, it seems that there are insufficient funds in the corporate account to make a substantial bonus payment (money is being siphoned out of the corporation as soon as it is earned). Accordingly, 2018 might look a lot like tax year 2017. I did, however, inform the client to begin running payroll immediately for the remainder of tax year 2018.

And to answer the questions posed by sjrcpa and Doug M as to the nature of the business, this C-corp would certainly qualify as a PSC, which adds to the fun.

Your thoughts are greatly appreciated. Thanks in advance!
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#15
JR1  
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You don't need money to cover the bonus. YOu offset the officer loan against it. You need money only for the taxes.
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
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#16
Doug M  
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As JR1 stated, you only really need the funds for the FICA (15.3%) plus some state payroll taxes. That should be doable for a person who netted $90k in 6 months.

The last thing you want is a 41% corp tax rate, and another 14% effective rate on the remaining 59%.
 

#17
AlexCPA  
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Thanks again! All of your insights are greatly appreciated.
Even more of my antics may be found on YouTube:
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#18
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Are you sure that treating the personal expenses as C Corp dividends will result in double taxation? What does the rest of his Form 1040 look like?
 

#19
TaxCut  
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Similar situation except client is on payroll with what looks like a fair salary.

Problem is he took distributions and didn't file 1099-DIV or 1099-MISC. Looks like prior accountant treated prior year distributions as 1099-MISC and put on 1040 Sch C though I don't see proof 1099's in prior year.

How would you handle? Treast as distributions and issue 1099-DIV or do as prior accountant and get them straight for this year?
 


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