C corp paying rent of sole shareholder

Was reviewing the books of a potential client and it is obvious that the C corp is paying the rent of the sole shareholder/employee. Well, we can't call this person an employee because the corporation has never issued this person a W-2. But ignoring the fact that this person hasn't been issued a W-2, can the C corp deduct the rent it paid that relates to this shareholder? He does work out of his home but there is not a separate building, or space. He lives in an apartment. Based on my research, 280A(c)(6) says that it isn't allowed. He doesn't have an accountable plan for reimbursement either. If it is allowable, I would assume he would need to pick this income up on his 1040 as rent income

Thanks

Whose name is on the lease as lessee? Let me start with the most extreme possibility, which I hate to do without knowing way more facts. Could this be fraud? Probably not, but …

Why no salary paid?

Does C corp. have earnings?

Could there be, oh, let's see, disguised dividends?

Would IRS get more by asserting salary or by asserting dividend?

What makes this possibly rent income to him? Is there a lease between the corp. and him? Does the lease between the owner and him allow sub-leasing? Does the building allow the conduct of a business?

Whose name is on the lease as lessee? Let me start with the most extreme possibility, which I hate to do without knowing way more facts. Could this be fraud? Probably not, but …

Why no salary paid?

Does C corp. have earnings?

Could there be, oh, let's see, disguised dividends?

Would IRS get more by asserting salary or by asserting dividend?

What makes this possibly rent income to him? Is there a lease between the corp. and him? Does the lease between the owner and him allow sub-leasing? Does the building allow the conduct of a business?

Before I respond, I think it will help to give my impression on this potential client. He is a dog trainer that is rather successful (not anyone famous but receipts are over 500k). He incorporated in 2008 and has had a friend do his prior year tax returns. I get the impression that he does not know that he is doing things incorrectly (ie: not taking a salary) because no one has told him. I can assume that he just started the business without knowing anything and blindly went along the way. Now, based on these assumptions (that I plan on talking to him about):

The lease is under his name personally. I don't see him privy enough to put it under the Corps name. When I first got the tax returns for 2011 and 2012, these payments were not on the financials but were deducted on the tax return as rent. This is when he told me that the prior accountant is the one that did it.

No salary because I'm sure he hasn't been told he needed to be. We will advise he needs to. He did pay himself but tried to code it as "contract labor" on the financials. We found it and have asked about it.

Disguised dividend. Sure, he was taking payments not in the form of salary.

C corp hasn't had earnings in the past. BUT, the prior year returns included the issues above as deductible expenses (paying the rent, no salary, no dividend, etc)

If the IRS came in, I bet they would reclassify the payments to salary so they would get the payroll taxes. I would be surprised if they wanted to call it a dividend since he isn't taking a salary. Now if he was taking a salary, might reclass it as a dividend

My initial thought was that he would need to pick up as rent income on his personal return, Schedule E, if these payments were somehow deductible on the C corp return.

Is the corp paying ALL of his rent? If so, it's problematic. And any excess over his home office usage (if any) would be something else - like salary or a dividend.

Is the corp paying ALL of his rent? If so, it's problematic. And any excess over his home office usage (if any) would be something else - like salary or a dividend.

Yes, the corp is paying his entire rent.

Does 280A apply here? Even if he was considered an employee (ie: he plays by our rules and will W-2 himself), can an employee rent his/her home to the corp? If it is allowed, we would report the rent payment as rental income on the 1040

Since he isn't an employee, what options would we have? Dividend payment? Nondeductible expense?

If this was a building he owned that wasn't his house, this would be much easier...

All I'm saying is that if the home office is 10% and the full rent is $1,000 per month, payable to the apartment complex, it makes no sense that the corp would pay $1,000 worth of rent to him each month. That is not fair rent for the corporation's use of 10% of the space. The fact is, the corp isn't using 90% of his apartment in this little example. More like $100 would be an appropriate rent amount (10% of $1,000). So, yeah, you could pick up the $1,000 as rental income on his 1040 - but it's really not rental income, if you will. It's excessive rent. It's the payment of a personal expense. It's compensation, a dividend, or maybe a receivable.

And - He is an employee. Just one that didn't receive any W2 pay.

One solution is to deduct what is fair and reasonable and treat the rest as a receivable...which he can repay.

But, the way things are now, the corp is basically paying for his housing - and the IRS ain't gonna like that too much. And I can't blame them.

When I first got the tax returns for 2011 and 2012, these payments were not on the financials but were deducted on the tax return as rent. This is when he told me that the prior accountant is the one that did it.

His accountant is doing him no favors. And, if the magic rent all of a sudden showed up on the 1120 as a deduction, I'm wondering how that happened. Accountant must have fudged the M1 or made some entry to Equity. Or something.

Ya, I get what you are saying, and that seems like a reasonable approach. Continuing with your example with the $100 as being reasonable, will the IRS even allow a deduction for this amount since he is an employee.

I keep saying that he isn't an employee because according to the financials and tax return, he was treated as an independent contractor. On paper he looks like an IC but yes, he is an employee and should be treated as such.

The prior accountant by my best guess reduced cash. The books showed approx $20k in cash while the tax return only showed $300. I can get pretty close to the cash number if I take the cash per tax return and add back the rent expense and a few other deductions that weren't on the books but were on the return

Did the corp issue him a 1099, as an independent contractor?

I've asked for copies of all 1099's so that is yet to be determined. Lets hope he did....

can the C corp deduct the rent it paid that relates to this shareholder?

This was the only question in the original post, but nobody has answered it without a bunch of collateral damage. Yes, the corporation can deduct it, either as compensation or as an operating expense for the work done at that location. Of course that assumes the amount is reasonable for the business purpose and supported by a W-2 or 1099.

can the C corp deduct the rent it paid that relates to this shareholder?

This was the only question in the original post, but nobody has answered it without a bunch of collateral damage. Yes, the corporation can deduct it, either as compensation or as an operating expense for the work done at that location. Of course that assumes the amount is reasonable for the business purpose and supported by a W-2 or 1099.

Thanks! Yes, that was really the question. Does the code allow a c corp to pay rent to its sole shareholder? If so, what code section could we look towards (is it just a general business expense under 162) or is disallowed under 280(A)? If it's allowed, would the corp issue a 1099 showing the payment as rent, so he picks up rental income, or would it be a dividend?

I think the best way to handle this is through an accountable plan and have him submit receipts. That way the corp gets the deduction and he is not taxed. (edit: I meant going forward. obviously cannot do it this tax year)

I know this client has issues and I've told him that if he wants us to do the work, we aren't filing on time. He contacted us yesterday....

that was really the question.... I think the best way to handle this is through an accountable plan and have him submit receipts. That way the corp gets the deduction and he is not taxed

Well, now the question has been doubled. I will still say yes, the corporation can deduct the payment. But now I will add, no, the shareholder can not exclude the payment.

Accountable plans are only valid if they can document expenses in good faith. Since the shareholder does not have a qualified home office, how could he allocate co-mingled costs? At least the way it is presented in this thread, it would look like the principal purpose is tax avoidance, just shifting personal expenses to the alter-ego corporation.

My "he can exclude the payment" comment was meant for the accountable plan only. As it sits now, I agree. The prior accountant just stuffed the IS with a lot of personal expenses, including these rent payments. In the past, they weren't treated as dividends or compensation.

For this year, if we do the work, we are thinking of either issuing him a dividend for the amount or a 1099.

Now, if we setup an accountable plan in the future, I would require him to fill out the 8829 and submit receipts to the corp.

if we setup an accountable plan in the future, I would require him to fill out the 8829 and submit receipts to the corp.

Receipts for what? In the original post, no part of the apartment met the definition of business use.

Guess that should've been cleared up. His apt is the only "office space" he has and the only place he performs business related duties whenever he is not at the client site. He is a dog trainer/dog sitter so when he is not at a clients site, he is at his apt answering emails, invoicing, paying business related bills, answering the phone, etc. What I'm saying is, part of his apt definitely meets the definition of business use. Not the entire thing, but part of it.

I've just never encountered a c corp that pays rent to a shareholder and wasn't sure of the rules. Looks like the code will allow it if done correctly

It will definitely allow it. It's very common for the shareholder to own the Real Estate and the corp to pay rent. Note that in your situation, however, you'd be dealing w/ a sublease arrangement, seeing that your individual client doesn't own the RE. Further note that you can only take the home office deduction for a dedicated space used regularly and exclusively. It doesn't necessarily have to be an entire room. So, it is unclear if your client meets these requirements. But if he does, you don't have to run this as a "rent payment." You'd do it more like a reimbursement. If the guy's rent is $1,000 per month and he uses 25% of the apartment as his office space, the corp could reimburse him $250 per month, on an expense reports, along with 25% of the utilities, etc.

part of his apt definitely meets the definition of business use

No, none of it meets the definition. There are special rules for working at home. If he uses his car 25% for business, sitting in the driver's seat, he can deduct 25% even though he also sits in the driver's seat for the other 75% which is personal. But no part of his home is deductible, no matter how much work he does there, unless there is no personal usage at all.

According to the original post, there is no separate space that is used exclusively for business, so there is no part of the small apartment that is not personal-use. "Rent" or reimbursement for personal-use space is not deductible except as compensation.

part of his apt definitely meets the definition of business use

No, none of it meets the definition. There are special rules for working at home. If he uses his car 25% for business, sitting in the driver's seat, he can deduct 25% even though he also sits in the driver's seat for the other 75% which is personal. But no part of his home is deductible, no matter how much work he does there, unless there is no personal usage at all.

According to the original post, there is no separate space that is used exclusively for business, so there is no part of the small apartment that is not personal-use. "Rent" or reimbursement for personal-use space is not deductible except as compensation.

I disagree. Part of his home meets the business use rules. That isn't what I'm asking or arguing. Just wanted to know if anyone has seen a c corp pay the rent of a s/h. Looks like it is possible, and probably best to setup an accountable plan (ie: reimbursement plan) substantiated with receipts, like CK mentioned.

Golf, you're misconstruing what 4S was saying. Your OP said:

He does work out of his home but there is not a separate building, or space. He lives in an apartment.

If that is the case, that he does some work at the kitchen table, and then the corner of his bedroom, and then on the couch...he has no dedicated space that he's using regularly and exclusively. He's likely using all those spots for other stuff (like eating dinner at the kitchen table, like watching TV from the couch, etc.).