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Lane
Lane, CFP, MBA, CRPS
Category: Tax
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Experience:  Providing Financial & Tax advice since 1986
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Accounting Question. A sus chapter S business has a net income

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Accounting Question. A sus chapter S business has a net income of $50,000 and there are two corp officers each holding 50% of the business which would give a K-1 to each of them for $25,000, However toe one officer took a draw of additional $30,000 which has to be accounted for . If added back to corp earnings this would increase both K-1 by $15,000 when only one should show the total amount. How would that be reflected in the 1120s. Could it be added to K 1 as additional income by the party receiving the draq. no taxes were withheld or any 1099 issused.

Thank you Frank Chrisie
Submitted: 1 year ago.
Category: Tax
Expert:  Lane replied 1 year ago.

NPVAdvisor :

Hi Frank

NPVAdvisor :

The phycal disbursement of dollars, and the reporting of net income for tax purposes are two different things

NPVAdvisor :

Because of the pass through nature of the S-Corp, if the Net income is 50,000 and the K-1s are showing the 25,000 for each that is correct

NPVAdvisor :

the draw WOULD adjust the one owners BASIS in the cusiness, but it's just a capital account transaction

NPVAdvisor :

oth ownsers could leave all of the profits in the business chacking acconts, but would still have to pay taxes on the profits as they are earned, for example

NPVAdvisor :

when they physically take the money, it's not a taxable event ... the taxable event is the year end profit

NPVAdvisor :

Distributions are a return of capital. As such they are not deducted by the corporation nor are they income to the employee/owner. (They do become taxable if they begin to exceed initial capital plus retained earnings).

NPVAdvisor :

Make sense?

Customer:

I just got this problem and the company has negative retained earnings. the profit ay year end was the $50,000 plus the additional draw by the one person. Do I show my profit as $50,000 plus the $30,000 draw as it was profit if so than it would be split between both people. I am missing something here??

NPVAdvisor :

OK, an S-corp (just as with Sole proprietorships, partnerships, and LLC's (unless they make an election to be taxed differently) are pass throughs ... which means that the S-Corp doesn't pay any taxes, but the profits or losses) for the year go to the owners on a K-1 and the owners pay that taxes at the personal level .. just one more thing ...

NPVAdvisor :

There are really three ways for the owner to get money out of the company ... (1) a salary (if they are involved with the business), which has payroll taxes, (2) dividends (which is that profit) and (3) drawing back money that was originally contributed or left in the companys retained earnings

NPVAdvisor :

On number three, that's a distribution and is not taxable because it's either capital that was contributed to the business by the owner (part of their basis in the company) or profits that were left in retained earned, but again, that money has already been taxed

NPVAdvisor :

You should be well aware that distributions in excess of Shareholder basis (negative retained earnings) is considered by the IRS as "sale of stock

NPVAdvisor :

How would you most likely get negative RE? Excess distributions over earnings is the most logical answer ...

NPVAdvisor :

Also when losses exceed profits. But where would the cash be coming from to take distributions if there wasn't enough profits to cover these distributions?

NPVAdvisor :

Maybe bank loans that they didn't spend on operations but are pulling out for personal use?

NPVAdvisor :

This is why the IRS calls this taxable income as Sale of Stock, and is taxable as a capital gain

NPVAdvisor :

Remember, profits increase basis, losses decrease basis - but basis can't be reduced below zero. Losses that are not deductible are suspended until basis is restored. ... either through additional capital paid in or future profits

NPVAdvisor :

This negative RE throws lots of red flage ... you need to sit down with the owners and see what's going on ... this is an areas HIGHLY scrutinized by IRS

Customer:

One last thing the Balance sheet shows RE as neg but the Total Liabilities and shareholders equity shows positive.. Look like entries were made to bring balance sheet in line??? Maybe I will just show the draw as part of income and split the K! as they are husband and wife but feting a divorce may be the best way to go ???

NPVAdvisor :

Look like entries were made to bring balance sheet in line??? Yep, bet this is NOT UN related to the divoce

NPVAdvisor :

the draw SHOULD adjust basis equally as they are 50% owners, but showing it as income is not correct. Taxes have already been paid on that moey

NPVAdvisor :

sounds like someone tok 30,000 that wasn't really there to take

Customer:

If I come up with a clean balance sheet that may raise a red flag as the balance sheet would change what do you thinj...also can I print out this response it would be of help to me??

NPVAdvisor :

I'd be VERY careful with this one, Again, sounds like someone took 30,000 that wasn't really there to take ... yes you can save this as a favorite place (bookmark), print, OR copy and paste into a document

Customer:

can I print this response out ???

NPVAdvisor :

Yes

NPVAdvisor :

you can also copy and paste

NPVAdvisor :

just do a file - print from your browser

NPVAdvisor :

Also, this will stay here (at this web-site: http://www.justanswer.com/tax/7tzl5-accounting-question-sus-chapter-business-net-income.html) for as long as you need it.

NPVAdvisor :

If this HAS helped, I would appreciate a feedback rating of 3 (OK) or better … That's the only way they will pay us here.


HOWEVER, if you need more on this, PLEASE COME BACK here, so you won't be charged for another question.

Lane, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 3645
Experience: Providing Financial & Tax advice since 1986
Lane and 2 other Tax Specialists are ready to help you
Expert:  Lane replied 1 year ago.
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Expert:  Lane replied 1 year ago.

Thanks so much Frank,

Good luck with it.

If you're doing their taxes, I'd strongly get them to sign a waiver that says you relied completely on information provided by THEM and just stick to reporting it as is, out of balance or not.

Thanks again
Lane

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