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BK-CPA, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 933
Experience:  Owner of a CPA firm
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I have a client with an S Corp he started in 2016.. He wants

Customer Question

I have a client with an S Corp he started in 2016.. He wants his 2014 return amended as he knows he made some mistakes. I am doing 2015 as well. He never paid payroll taxes or had any sort of payroll done. Obviously, he SHOULD have paid himself something. He also does have a full time job, and make a w2 income, but it does not pay well. But he has had a 40 hour per week job. At this point, should I try to pay payroll. Or is it too late for that. I suppose I can take all the money as flow through dividend. And make him do it right in 2016.
Submitted: 7 months ago.
Category: Tax
Expert:  BK-CPA replied 7 months ago.

Hello and thank you for your question.

You state that he started the S-corp in 2016. Given that, I'm not sure why he would be paying himself a salary from the S-corp in 2014 and 2015. If I assume he had his S-corp in 2014, that makes more sense.

You already realize that a proper salary is a requirement. If he has taken distributions from the S-corp in prior years it's almost a guarantee that the IRS would reclass these as compensation under audit. You can inform your client of his exposure and offer to prepare the required payroll tax filings. It will be up to your client as to what to do.

If your client wants your advice, I would use your best judgement based on the amount of distributions taken and his involvement with the S-corp before assisting your client in determining business risks associated with the relative likelihood of being audited. Some leeway may be afforded in the S-corp's formative years where the corp doesn't really have the earnings or extra cash to pay salaries or make distributions, but that is up to the IRS as to whether or not it wants to press the issue. You cannot advise a tax position based on playing the audit lottery, but when a client has already taken the position and is trying to measure the business risk associated with not amending you can take it into consideration. There is no absolute answer to that.

I hope this is helpful.

Customer: replied 7 months ago.
Sorry for my typo. The Corporation started in 2014. If I just let the compensation come to him as flow through income, what is my and the taxpayer's risk?? He does have a full time job and this was done without my knowledge or advice. So if I just report what occurred as what occcured, is my a__ covered? He is amending 2014 due to other errors and 2015 I am doing. He definitely made a profit, probably around 80k per year. He did not pay himself pay. The years are over. No Payroll tax w/h was done. If I go back and give him pay, how does this work??? He did not make the quarterly filings. So he would be subject to penalties on this, right? He has no W2s done. It seems like the only realistic approach is to file as what actually happened--inform my client he screwed up and should have paid himself a salary, and that it is possible the IRS will reclassify some of his income as pay, and tax him for it,-- and file the returns on this basis. Do you agree? Or is there a better approach? I am not really comfortable doing this, but do not see a real good option otherwise. I would hope the client has a 40 hour a week job also helps, as he could say with some truth the corporation is an after job activity and he simply wants to take whatever his profit is, and if there is no profit, there is no pay. What do you think?
Expert:  BK-CPA replied 7 months ago.

It's impossible to accurately calculate risk in this case because you can't perfectly ascertain whether or not the IRS will choose to audit. You also have to use your judgment, again, based on whether he took distributions and what his time involvement was. His other job helps to show he maybe wasn't working full time for his S-corp, but that doesn't mean he shouldn't be taking at least some form of salary for what he did do in an employment capacity.

If you amend 2014 and you know that his distributions are properly classified as compensation but you do not do anything about it and sign the return anyways, then you open yourself up potentially, yes. IRC 6694. You can do what some preparers try which is show some of the distributions as self-employment income for which he'll remit self-employment taxes to reduce the exposure, but that is not technically the correct way to deal with this and I don't personally suggest it.

Yes, he would face penalties on the payroll taxes if he goes to file them now. That's a given. You can write the IRS and beg for some leniency or try to use the first-time abatement waiver.

The only correct way to proceed is to file the payroll tax filings for what would be a reasonable wage in this circumstance. I can't waive a magic wand for you or tell you that it's ok to fudge it just this once or something. You have to make a choice based on what you feel your own business risk is as compared to the reward.