Statute of limitations - 1120S and 1040

Need help navigating statute of limitations rules. I'm confused as to how they apply to an owner of a PTE.

Taxpayer is the sole shareholder of an S corp. The S corp's 2018 income was understated by approx. $100k. This understatement was due to distributions miscategorized as subcontractor expenses on the 1120S. Because of this, the Taxpayer's income on their 1040 would also be understated by approx. $100k.

This understatement is "substantial" in that the Taxpayer's 1040 income was understated by > 25%.

The due date for the 1120S was 3/15/2019 (not extended nor filed late).

The due date for the 1040 was 10/15/2019 (not filed late).

My questions are:

1. Is the S corporation's statute of limitations extended to six years because of this error? The error was due to a deduction vs. an omission of income.

2. If the S corporation's statute of limitations passes, can tax still be assessed against the Taxpayer because of the error on the 1120S?

1. No.
2. The 1040 has a six year SOL because of the 25% rule. For such purpose the S corporation SOL is immaterial.

1. Agree with Gator: No.

2. The individual may not be understated by 25% for SOL. The $100k represents the change in net income from the S corp. However, for SOL purposes, gross income is considered. The individual must look to his/her allocated amount of gross income from the S corp (in this case 100%) to determine if the 25% threshold has been met.

However, for SOL purposes, gross income is considered. The individual must look to his/her allocated amount of gross income from the S corp (in this case 100%) to determine if the 25% threshold has been met.

Could one argue the $100k distributions are actually payments made to the shareholder, perhaps wages that didn't run through payroll, that should be included in their gross income separate from the corporate income?

Uh, no.
Go Pack Go!

Could one argue the $100k distributions are actually payments made to the shareholder, perhaps wages that didn't run through payroll, that should be included in their gross income separate from the corporate income?

Well, if you increased SH wages which in turn decreases SH passthrough net income, how would that change anything? But it appears to be a moot point for the 25% gross income calc. For the gross income calc, the SH needs to look at the gross income of the S corp.

Well, if you increased SH wages which in turn decreases SH passthrough net income, how would that change anything?

Would the Taxpayer's gross income increase due to the increased wages? Would that be enough to extend the TP's SOL out to six years?

Would the Taxpayer's gross income increase due to the increased wages? Would that be enough to extend the TP's SOL out to six years?

No, the 100% SH's gross income would not increase. If you take the distribution and recharacterize it as SH wages you also get an offsetting deduction for the wage expense. Net change to SH = $0.

My point is that the increase of $100k may not actually be an increase of >25% of gross income for the SH. To determine the SH's gross income you have to also take in the gross income of the S corporation not just the passthrough amount from the K-1. For example:

100% SH has $200k in wages before considering the K-1. The K-1 now passes through $100k of unreported income. In looking at this, one would say that the $100k is >25% of gross income.

However, to determine if the $100k pushes the SH past the 25% mark, you have to add the gross income of the S corp to the SH gross income. So, let's say that the S corp had $1MM of gross income with a net passthrough income of $100k. The SH's gross income is now $1.2MM ($200k wages + $1MM S corp gross income). The $100K unreported income does not push the SH past >25% threshold.

I hope this makes sense.

I hope this makes sense.

This did make sense. I appreciate you typing up the explanation, it helped a lot. It's only mid-January and already my brain is in shambles.

I stand corrected. I only dealt with the numbers in the OP and assumed that was all of the income for purposes of the 25% test.

However, I have to disagree with
However, to determine if the $100k pushes the SH past the 25% mark, you have to add the gross income of the S corp to the SH gross income. So, let's say that the S corp had $1MM of gross income with a net passthrough income of $100k. The SH's gross income is now $1.2MM ($200k wages + $1MM S corp gross income). The $100K unreported income does not push the SH past >25% threshold.

§ 1.1366-1 Shareholder's share of items of an S corporation.
(3) Nonseparately computed income or loss. Each shareholder must take into account separately the shareholder's pro rata share of the nonseparately computed income or loss of the S corporation. For this purpose, nonseparately computed income or loss means the corporation's gross income less the deductions allowed to the corporation under chapter 1 of the Internal Revenue Code, determined by excluding any item requiring separate computation under paragraph (a)(2) of this section.

However, I have to disagree with
[i]However, to determine if the $100k pushes the SH past the 25% mark, you have to add the gross income of the S corp to the SH gross income. So, let's say that the S corp had $1MM of gross income with a net passthrough income of $100k. The SH's gross income is now $1.2MM ($200k wages + $1MM S corp gross income). The $100K unreported income does not push the SH past >25% threshold.

But your cite refers to the shareholder's distributive share of income/loss for tax purposes, not for purposes of §6501(e). You need to keep reading:

Reg. § 1.1366-1(c)(2)(i):
(i) In general. For purposes of determining the applicability of the 6-year period of limitation on assessment and collection provided in section 6501(e) (relating to omission of more than 25 percent of gross income), a shareholder's gross income includes the shareholder's pro rata share of S corporation gross income (as described in section 6501(e)(1)(A)(i)). In this respect, the amount of S corporation gross income used in deriving the shareholder's pro rata share of any item of S corporation income, loss, deduction, or credit (as included or disclosed in the shareholder's return) is considered as an amount of gross income stated in the shareholder's return for purposes of section 6501(e).

THANK YOU!

Thank you both for the helpful information. I didn't expect there to be a 6501(e) reference in the S corp regs. This has been a great learning experience.

Thank you both for the helpful information. I didn't expect there to be a 6501(e) reference in the S corp regs. This has been a great learning experience.

You’re welcome. The 6501(e) reference is also in the partnership regs. Just an FYI.