S Corp Owner Wages - "On Paper" - but no DD/checks

I'm sure this comes up with many of you - because I frequently have new s corporation owner/employee clients coming from other firms who....

1) Run payroll, make pay stubs, file all payroll tax returns, make all payroll tax deposits, pay SUTA, etc...

2) Do not actually write a check for the net pay or receive a direct deposit form the s corporation business account to their personal account.

I make them write a check each month.

Am I being too strict?

No you're not. What kind of books do they have/not have? Without payment of the net payroll what would be recorded?

Very weird situation. Would the 'unpaid' wages be considered additional contribution of the owner to the S-corp?

Surely he's taking 'advances' that get book to S/H loans or some such and payroll settles it up?

Does he have his hand in the till? Is this a restaurant? Sounds like he is trying to offset something underhanded. I saw this once decades ago.

You are not being too strict.

Nothing underhanded. Maybe I didn't explain it well.

S corp owner, who provides more than minimal services for his business, pays himself a salary of $60,000 though payroll. After his wages and the other expenses, his net profit is about $30,000 - which he takes in distributions.

For the $60,000, he runs payroll through Intuit. $5000 per month. His monthly pay stub reads, for example (I'm making the numbers up), $5000 gross, $1000 federal income tax withheld, $500 state income tax withheld, and the stub shows the FICA withheld. The net pay on the stub says $3107.50

He makes a monthly 941 deposit in the next month for about $1392.50, and also the state WH deposit of $500.

He files a quarterly 941, an annual W2/W3 and 940, and makes quarterly SUTA (UI) payments and filings. Etc. He files and pays everything....

Except...

He doesn't actually write himself a check for the $3107.50 every month. He skips that part.

He says, "my last CPA told me that I don't actually have to write the paychecks to myself for the exact net amount every month - that's its the same thing either way - as long as I'm running the payroll on paper and making all of the payroll filings and deposits."

This makes sense to me, actually, but I'm the nervous type - so anything like this makes me think twice

What's being asked is, absent a check each month, are we to assume the net pay of 3107.50 stays in the corp? If so, it has effectively been contributed to capital (APIC). Then you tell us he takes the income left after wages to himself as distributions, almost begging IRS to look at calling some or all of it wages. Why do that? Leave the ($30,000) income in the corp., and reduce the salary, to save some FICA.

Oh, I see Nilodop. This actually leads me toward an answer (your posts do that a lot)

I'm not 100% sure because I didn't ask him yet, but looking at his tax returns, this is his only source of income, and the M2 and L are extremely simple, with minimal cash, etc.

It looks like he is distributing everything except what he needs to leave in the bank to operate, which isn't that much.

I would guess that the checks include the net pay from his $60,000 salary co-mingled with the ~$30,000 per year in net profit (taken pretty much in full as distributions).

So if he writes a $6000 check to himself each month, would it hold up if he was to claim that this check is a split transaction with $3107.50 of it as net wages and $2892.50 as a shareholder distribution? He would just be adding his distribution to his salary paycheck in the same transaction.

I feel like this is a bit sloppy, but legitimate?

I've seen SCorp share holders cut the checks but not cash them because of cash flow. As the cash flow improves, they will first reimburse out of pocket expenses and then cash what they can and at the end of the year put the uncashed checks into APIC. They would not take a distribution.

I feel like this is a bit sloppy, but legitimate? Yes.

While this may be "okay" for tax, I strongly suspect he is blowing any and all legal protection of the entity by doing what he's doing. That alone may be enough to convince him to change course. Advise him to consult his attorney.

Leave the ($30,000) income in the corp., and reduce the salary, to save some FICA.

This, 100%.

I do not feel it is inappropriate if they do a transfer from corporate account to a personal account for the net amount of a calculated paycheck. I have clients do this and it is substantiated by their pay stubs, which have "Transfer" recorded as the payment reference.

Then there are the clients that convert distributions to payroll at various points in the year or at year end, and while against the IRC, let's face that it is common practice as small S-Corps. This latter method is ONLY on paper because the money has already been paid out. I used to be more accepting of this, since I had the attitude the government was still getting their money, but I do not like it anymore and encourage against it.

As to combining net payroll with a distribution? To me, that is a terrible practice despite filing payroll reports and paying payroll taxes. If audited, the IRS will want to see more than the 941s and he is at risk of all of those combined checks or transfers being classified as wages (unless he can somehow prove what he is doing and they accept his justification, and that $60k is his reasonable compensation). If it were one of my clients doing it, I would tell them to either write separate checks or do separate transfers--DO NOT COMBINE. Good grief, it isn't that difficult to do it separately...

I would agree there is nothing "technically" incorrect in this practice. You can work out the bookkeeping on the back end.

HOWEVER, they've completely ignored the corporation dynamic by practicing in this manner. The bigger issue is they aren't drawing a line between themselves and the business. Why bother having a Corp if you're not going to respect its existence?
Yes, it is more of a legal dynamic than a tax one, but the dynamic DOES have substance.

I’ve run into a number of people instructed to do it that way when they’re solo S-Corps. Take a check as you need it and put it to current year distributions. Once a quarter, do a journal entry to for payroll against current year distributions.

I know the Watson Group puts out a ton of content. This is how they instruct clients to do it on their website.

The same Watson that got pinched by the IRS a few years ago?

Not sure, I don’t know anything about it?

I'd say that this isn't uncommon....so just book the advances to his note and make the entries when he runs payroll....