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Lev
Lev, Tax Advisor
Category: Tax
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Experience:  Taxes, Immigration, Labor Relations
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Hi all...I am a CPA, and have a single shareholder, s corp.

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Hi all...I am a CPA, and have a single shareholder, s corp. He recorded his s corp income on his schedule C - subject to SE tax. The IRS is now looking for 1120S returns. He has not been on payroll. When I prepare the 1120S and amend his personal returns, it wipes out the SE tax. It doesn't seem right, but what else can I do?
Submitted: 3 years ago.
Category: Tax
Expert:  Lev replied 3 years ago.

Lev :

Hi and welcome to Just Answer!
If there is no self-employmet inconme - there woudl no SE tax liability.
However - when income will be reported on 1120S - and If there will ne positive net income - the IRS will expect that S-corporation pays wages to teh shareholder - and there will be employment tax liability on the S-corportaion.

Lev :

Sorry for typos..
However - when income will be reported on 1120S - and If there will be positive net income - the IRS will expect that S-corporation pays wages to the shareholder - and there will be employment tax liability on the S-corporation.

Lev :

As you might know - according to the IRS - S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly.

Lev :

Because income was already reported on individual tax return - you may try to avoid employment tax issue if S-corporation pays to the owner as a contractor and issue 1099MISC - so there will be NO income on S-corporation tax return and the taxpayer personally will have self-employment income. So - overall tax liability will be the same - but the person personally will pay both income taxes and self-employment taxes. Technically - that is not correct - but the IRS might accept as long as all income is reported and taxed.
If S-corporation has relative large net income AND there is no wages paid by S-corporation, but such income is passed to teh shareholder via K1 - it is very likely that the IRS audits you and could assess employment taxes with penalties and interest charges. So - you might want to avoid such situation.

Lev :
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That what I would do in such situation to avoid employment tax assessment. That will not provide any difference in tax liability because actually employment taxes would be converted to self-employment taxes - and liability will be shifted from S-corporation to you personally. S-corporation will pay penalty for late filing of form 1099 - but that is a small amount.


Please be aware that technically - that is not correct - and the IRS still may apply penalty for not paying wages - but as long as all income is reported and all taxes are paid - that would be very unlikely.



Customer: replied 3 years ago.
thanks Lev...so why not just go back and do W-2 and payroll tax returns for the three years - rather than 1099?
Expert:  Lev replied 3 years ago.
Hi again,
Getting back and setting a payroll in S-corporation would be the correct way to handle the situation.
What I offered - is a way around which might reduce possible liability.
However - S-corporation will have significant penalties for late filing and late payment of payroll taxes.
While I agree - that would be correct and clear way to proceed - still suggest to estimate expected tax (and penalty) liability - and provide that information to the client.
I honestly suspect that the client will not be happy with these numbers...
Still - it is possible to ask the IRS to abate penalties - but there is no guarantee the IRS would agree to abate.

Regardless - going back and doing W2 and payroll tax returns for the three years - that is a correct and valid option but the cost should be estimated.
Lev and other Tax Specialists are ready to help you