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CGCPA
CGCPA, CPA
Category: Tax
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If the shareholders in an s corp had salary in arrears on Dec

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If the shareholders in an s corp had salary in arrears on Dec 31, 2010 because the company couldnt afford to pay them, would the unpaid salary need to be reported as section 409a income on the 1099-misc? We have only been in business since August 2010 and we paid the shareholders as independent contractors on a job by job basis. I realize now this is not a good way to do it but it is too late now for 2010 but have started taking payroll taxes out on payments for 2011.
Submitted: 5 years ago.
Category: Tax
Expert:  CGCPA replied 5 years ago.

Welcome to Just Answer. I am here to help you resolve your tax and finance concerns. Please feel free to ask anytime you need extra help.

 

There are two ways you can deal with this and the choice may not be yours.

 

Choice 1

 

You can record the obligation to the shareholders if the S Corporation is on the accrual basis. It will then take the deduction. The subsequent payment to the shareholders will not have taxes withheld and will be recorded on the S Corporation's records as a reduction in the obligation. The shareholders, because this is a closely held entity, must then declare the income in 2010 for tax purposes. When paid it will not be treated as taxable again. The key here is that this is only valid if the S Corporation is on the accrual method.

 

Choice 2

 

This choice is available whether the S Corporation is on the accrual basis or the cash basis. Do not record anything for this in 2010 on the S Corporation or individual shareholders' returns. When paid in 2011 taxes should be withheld and the expense recorded on the S Corporation's records and the shareholders' taxes.

 

The crucial point here is that both sets of tax reports must agree because of the closely held nature of an S Corporation.

Customer: replied 5 years ago.
Just to clarify...The company is on an accrual basis, so it would be acceptable to report it on the company's 2010 return but wait and report the income on the shareholders 2011 returns?
Expert:  CGCPA replied 5 years ago.
No, if the S Corp takes the deduction, the shareholders must also claim it in 2010. If you do this it will not change their tax situations very much since one will offset the other.
Customer: replied 5 years ago.

So it would be reported as 409A income and also as nonemployee compensation on the 1099-misc. And basically the 409A income is deducted from the nonemployee compensation when taxes for 2010 are figured? Then it would be reported again in 2011 and that is when taxes will be paid?

Expert:  CGCPA replied 5 years ago.
No. The income will be reported to the shareholders on Form 1099-MISC and not on the K-1 or anywhere else. It should match the deduction/liability shown by the S Corporation for 2010. When paid in 2011 the corporation will reduce its debt to the shareholders and not recognize an expense.The shareholders must, on their part, recognize the income in 2010. The shareholders will not recognize the income again. That would double the income they pay tax on.In other words, the shareholders must recognize the income in the same year the S Corporation claims a deduction. When it is actually paid is purely a balance sheet activity.
Customer: replied 5 years ago.
So on the 1099-misc would the unpaid income be reported in box 7 "nonemployee compensation" or box 15b "section 409a income" or both?
Expert:  CGCPA replied 5 years ago.
It goes in box 7 as non employee compensation.
CGCPA and other Tax Specialists are ready to help you
Customer: replied 5 years ago.

Thanks!