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S Corp - Payroll After Year-End

Technical topics regarding tax preparation.
#1
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Employment tax compliance is not my wheelhouse, so I apologize for what may be a dumb question...

Brand new client that I picked up recently. He wholly owns an LLC taxed as an S Corp. The S Corp is cash basis. He is the only employee.

He provided me with a 2019 W-2 (from the S Corp to him) along with the related payroll tax returns that were prepared by another accountant. The salary and related withholding & employment taxes did not come out of his business checking account until 2020 and thus do not show up on his 2019 S Corp P&L.

I'm rather confused about what to do here... Obviously if the W-2 income is reported on his 1040 with the flow through income from the S Corp sans the related compensation deduction it's going to hit him particularly hard.

Do we amend the payroll returns and issue a corrected W-2?

Also, health insurance premiums were paid on his behalf by the S Corp during 2019. These were not reflected in Box 1 of the W-2 like they should be. So bare minimum I imagine I'll have to prepare a W-2C for that.
 

#2
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I would just do an AJE. Debit wages and payroll taxes and credit payroll tax liability and shareholder loan. It would be like he took the cash and immediately loaned it back to the company. Then when he received the net wage in 2020 it will offset the loan. I would amend the W2 and 941 to add on the health insurance.
 

#3
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swgordon wrote:I would just do an AJE. Debit wages and payroll taxes and credit payroll tax liability and shareholder loan. It would be like he took the cash and immediately loaned it back to the company. Then when he received the net wage in 2020 it will offset the loan.


Agree.

swgordon wrote:I would amend the W2 and 941 to add on the health insurance.


No need to touch the 941...just update Box 1 of the W-2 for SEHI
~Captcook
 

#4
MWPXYZ  
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You may want to read Vanney Associates, Inc. (TC Memo 2014-184) to see what could go wrong.

In NH, even with S corporations it was, until the last couple of years, a common procedure to zero out corporate profits that would give rise to NH Business Profits Tax. And, for the last 40 years I have not had a client, or heard of a taxpayer, who underwent the same scrutiny as Mr. Vanney.

OTOH, perhaps he is recording payroll in order to account for previous advances. In that case read Ken Ryan, Inc. (TC Summary Opinion 2010-18 to see what could go wrong.
 

#5
AlexCPA  
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I would just do an AJE. Debit wages and payroll taxes and credit payroll tax liability and shareholder loan. It would be like he took the cash and immediately loaned it back to the company. Then when he received the net wage in 2020 it will offset the loan. I would amend the W2 and 941 to add on the health insurance.


Is this not a substance-over-form issue?

Per an article in the The Tax Adviser (https://www.thetaxadviser.com/issues/20 ... ruals.html -- I know, not authoritative), please note:

...a cash-basis taxpayer cannot use the recurring-item exception and is therefore only able to deduct FICA, FUTA, and state unemployment taxes in the year paid.


Furthermore, this issue was covered in another post (viewtopic.php?f=8&t=10099) in which Coddington quoted the following from the Tax Court:

We now turn to the third issue, which concerns the deductibility of the FUTA taxes and of the employer's portion of the FICA taxes. Secs. 3301, 3111. Petitioner incurred liability for these taxes with respect to wages paid to the employees of his law practice. On Schedule C of their tax returns, petitioners deducted these taxes for the year in which the liability accrued (i.e., the year in which the wages were paid), even though petitioner did not pay the tax until a later year. Petitioners argue that this treatment was proper and was in compliance with section 1.461-1(a)(1) and (3), Income Tax Regs. We disagree. Section 1.461-1(a)(1), Income Tax Regs., provides deductions for depreciation, amortization, depletion, and losses under sections 167, 611, and 165. Nothing in section 1.461-1(a)(3), Income Tax Regs., allows a cash basis taxpayer to deduct a tax before the year of payment. See also Rev. Rul. 74-70, 1974-1 C.B. 116 (for cash basis taxpayers, FICA and FUTA taxes are deductible for the tax year in which they are paid). Accordingly, petitioners may not deduct either the FUTA taxes or petitioner's share of FICA taxes until the year in which he paid such taxes.Tippin v. Commissioner, 104 T.C. 518, 532 (1995)
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#6
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...a cash-basis taxpayer cannot use the recurring-item exception and is therefore only able to deduct FICA, FUTA, and state unemployment taxes in the year paid.

This is not true. Pretty much all companies have year end payroll tax liabilities. December payroll taxes (941) are not even due until 1/15 or 1/31 if under $2500. FUTA taxes are not due until 1/31. I see nothing wrong with this situation. The payroll taxes were paid in January like they should have been.
 

#7
AlexCPA  
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swgordon wrote:This is not true. Pretty much all companies have year end payroll tax liabilities. December payroll taxes (941) are not even due until 1/15 or 1/31 if under $2500. FUTA taxes are not due until 1/31. I see nothing wrong with this situation. The payroll taxes were paid in January like they should have been.


Respectfully, the Tax Court seems to disagree (emphasis mine):

Nothing in section 1.461-1(a)(3), Income Tax Regs., allows a cash basis taxpayer to deduct a tax before the year of payment. See also Rev. Rul. 74-70, 1974-1 C.B. 116 (for cash basis taxpayers, FICA and FUTA taxes are deductible for the tax year in which they are paid). Accordingly, petitioners may not deduct either the FUTA taxes or petitioner's share of FICA taxes until the year in which he paid such taxes.Tippin v. Commissioner, 104 T.C. 518, 532 (1995)
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#8
novacpa  
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What box is checked on prior year's tax returns? Cash or Accrual.
If it's Cash he's in tight sneakers.
Lesson to be learned - the hazards of last minute tax work.
 

#9
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So if the payroll taxes can't be deducted until paid, can the salary be deducted before paid? [edit, assuming a cash basis taxpayer]
 

#10
Nilodop  
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dellpaul in #9 brings us back to what I think is OP's main concern, stated by OP in OP as Obviously if the W-2 income is reported on his 1040 with the flow through income from the S Corp sans the related compensation deduction it's going to hit him particularly hard.. The payroll tax aspect is also a concern, but I think not OP's main one.

So are we not asked mainly to advise, given that client corp. is cash method, and issued to sole shareholder (also cash method) a W-2 for 2019, whether somehow the shareholder has salary income for 2019 and also S corp income, unreduced for that salary expense, in the same year? Is that even possible?

swgordon and CaptCook seem to agree on a pragmatic solution, perhaps based on a constructive receipt/constructive payment concept, and perhaps also based on the fact that the other accountant, the one who prepared the W-2, may have been following a long-standing (maybe correct, maybe not) accounting practice.

What should OP do?
 

#11
MWPXYZ  
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267 seems to indicate the treatment of compensation must be reported in the same year for both parties.
And the day that the payroll occurs is the day that the employee reports the income.

Would a promissory note between the corporation and the employee, dated in 2019, allow for a 2019 treatment?
The criteria for a promissory note seem to make the efficacy of a promissory note doubtful. See Reg 1.61-2(d), Rev Rul 71-117, and Robert J Dial 24 TC 117 (1955). There are many more court cases that parse distinctions between promissory notes that "count" for cash basis taxpayers and those that don't.

Some CPE indicates that: The courts have determined that the following conditions are necessary to tax an amount under the doctrine of constructive receipt: (1) the amount must be due; (2) the amount must be appropriated on the books of the obligor; (3) the obligor must be willing to pay; (4) the obligor must be solvent and able to pay; and (5) the obligee must have knowledge of the foregoing facts. In essence, the obligee's demand for payment must be the only thing that would be necessary for payment.

Furthermore:

Would the client have less taxes to pay if the W-2 were amended to $0?
Would the loss of the deduction for health insurance premiums, due to no wages, be a significant issue?
Does the client need the federal taxes withheld from the W2 to avoid significant penalties from underpayment of estimated tax?
 

#12
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Were there no distributions to the SH/employee during 2019?

If there were, recharacterize these payments to reflect the net payroll they were intended to represent in retrospect.
As far as the payroll taxes, I've always taken the position these are liabilities and not accrued expenses, which means they are not an accrual to cash ADJ and properly are reflected on a modified cash (tax) basis balance sheet.
~Captcook
 

#13
Doug M  
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Gotta assume the payroll check is dated in 2019. I see a couple of posts that refer to payroll taxes when it is better described as withheld taxes. Payroll taxes are paid and deducted in 2020.

The S corp is holding trust funds to be paid in 2020. I've got no problem with it. We book a liability for payroll taxes withheld. This is how we get payroll to gross when the withheld taxes are paid in the next year. Client probably is 15th day next month payroll tax depositor. That payment is timely. Due to shareholder? Reduce distributions? Reduce cash? Let's just be happy that the client took payroll. Talk to client about monthly payroll. You can get hammered if you take distributions all year with no payroll until December.
 

#14
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novacpa wrote:What box is checked on prior year's tax returns? Cash or Accrual.


Cash.

MWPXYZ wrote:Would the client have less taxes to pay if the W-2 were amended to $0?


Yes, because of the dynamic between reasonable comp and QBID. But wouldn't we have to amend the 941 and 940 as well? And try to get back payroll taxes paid, or worse carry them forward (i.e. they are "locked" up)?

MWPXYZ wrote:Would the loss of the deduction for health insurance premiums, due to no wages, be a significant issue?


Numerically no.

MWPXYZ wrote:Does the client need the federal taxes withheld from the W2 to avoid significant penalties from underpayment of estimated tax?


N/A. No federal income taxes were withheld on the W-2, only FICA. Don't ask me why...

CaptCook wrote:Were there no distributions to the SH/employee during 2019?


There were, but not enough to cover the W-2 reasonable comp. Roughly only 50%.

Doug M wrote:Talk to client about monthly payroll. You can get hammered if you take distributions all year with no payroll until December.


Better believe I will. It's going to make my life easier if he does quarterly instead of this again.
 

#15
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Doug M wrote:You can get hammered if you take distributions all year with no payroll until December.


Can you provide some authority for this?
I'm assuming the payroll taken in December is reasonable in total.
~Captcook
 

#16
Nilodop  
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That was already provided by MWPXYZ. https://casetext.com/case/ken-ryan-inc- ... al-revenue.
 

#17
MWPXYZ  
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MWPXYZ wrote:
Would the client have less taxes to pay if the W-2 were amended to $0?

Yes, because of the dynamic between reasonable comp and QBID. But wouldn't we have to amend the 941 and 940 as well? And try to get back payroll taxes paid, or worse carry them forward (i.e. they are "locked" up)?


I would amend and explain that payroll was not really paid until 2020.
Since the refund of the overpayment won't probably show up for a couple months I would consider applying the overpayment to 1Q 2020. He has a head start to the 2020 payroll!

The qualm I have had with applying an 941 overpayment to the next quarter is that in preparing the 1Q 941 in April and using that over payment as a credit, and then filing the 941: the 4Q 2019 overpayment then shows up at the client's office in the form of a refund. You should mention that if he receives a check from the IRS in the amount of the "2019" payroll tax deposit, he should not cash the check.
 


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