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PDtax, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 4677
Experience:  35 years tax experience, including four years at a Big 4 firm.
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My client was advised to incorporate her existing restaurant

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My client was advised to incorporate her existing restaurant business, which is a sole proprietor located in California. The date of incorporation with the California Secretary of State is May 7, 2009 and stock certificates were issued to it's one shareholder. The company that prepared the incorporation stated that an S election was filed and I recently confirmed with the IRS that in fact they never received the Form 2553. A second shareholder was issued stock on June 9, 2011. My client never did not transfer the business into the corporation. All they have done is used the EIN on their new bank account (which states the sole proprietor name and the DBA) This bank account was opened in March of 2012. My client also used the EIN on sales tax returns beginning on April 1, 2011.
I am concerned that the IRS will demand 3 years of C Corporation tax returns, which will result with a large amount of dividend income for the distributions made to the business owners.
I would like to receive a lot of input from you tax attorneys with regard to this situation.
I would like to know if closing the corporation due to no transfer of assets nor the incurring of liabilities took place, as well as no operations took place with in the corporation. The business continued to operate as a sole proprietor and has filed Schedules C in the tax returns of the owner up until 2010. The 2011 tax return is on extension.
What do all you tax attorneys advise as the best solution.
Submitted: 5 years ago.
Category: Tax
Expert:  PDtax replied 5 years ago.
hi from just answer.

I think you know the standard answer, since the operating assets were never transferred. The entity was just used for banking, and sales tax reporting, but owned no assets. The standard answer is the income should be reported on Schedule C, file tax returns as if the new corp was just used for banking and reporting, and pay the penalties.

I find this happens a lot more that people are forming their own corporations and business entities without professional guidance. But, I think I have a solution.

Since it was the shareholder's intent to use the assets of the business to earn, perhaps a lease can be drawn up outlining the shareholder's intent, and reflect rental income to the owner (with matching depreciation) on the shareholder's schedule E. The corporation, a C corp, reports its income and expenses, claims rent paid to the owner of the assets, and returns reflect the owners' true intent.

The issue is the lease agreement, which should be drawn up professionally to commemorate the owners' intent.

Thanks from Just Answer.

PDtax and 3 other Tax Specialists are ready to help you
Customer: replied 5 years ago.
The market lease rates would not eliminate all of the dividend income that would have to be reported by the C Corp. In addition, 3 years of individual tax returns would need to be amended plus 3 years of 1120's. In addition there is the risk that this would open up a can of worms with the IRS and FTB costing my client much more in fees. Wouldn't it be right and easier to amend the sales tax returns and correct the EIN on the bank account and close the C corp and just be done with it. Is this not an option?
Expert:  PDtax replied 5 years ago.
the corporation income is taxable income from operating a paymaster or similar entity.

It sounds like the owners took money and never paid tax on it. Maybe this helps clean that up too.

monies distributed could be treated as loans, settled when the lease arrangement is established or W-2 out after the corporation setup is repaired.

Amending returns just makes this ugly. The old years have been reported. Leave them, repair the setup going forward, and report 2012 with the lease payments (avoiding sales tax on transfers) putting the assets to use. You didn't mention if depreciation was claimed, but that is a separate issue.

Thanks from Just Answer.
Customer: replied 5 years ago.
What is the risk of filing an S election in 2012 after the stock was issued in 2009. The stock issue dates have to be reported on the Form 2553. Wouldn't the IRS and FTB ask why no returns have been filed for previous years?
On another note, the business operated as a sole proprietor, thus the owner took owner's draws, which are not taxable.
The building is a capital lease and we expensed depreciation on the 2010 tax return that I amended for other reasons not mentioned in our conversation. Thus we are taking advantage of depreciation.
I still don't understand what we would lose if the corporation was simply closed. If the client still wants to have an S Corp, we can incorporate a new company and do it the right way.
Expert:  PDtax replied 5 years ago.
no risk of conversion to s in 2012.

so, let's review what the story is.

corp didn't file income tax returns, but files sales tax returns and did banking.

If owners reported all income as schedule C, report corporate income/expense as in/out, with no tax due. Perhaps you could report sales on 1120 as 300,000, with a reduction that says reported by (shareholder ss) 300,000, for 0 sales. Same with expenses, reporting them all in detail, with a corresponding addition for reported by shareholder ss on 20XX 1040 schedule C). No corporate income tax, just late filing charges.

You will have to file all the old returns before you could set up a new corp in your shareholder's name. A new corp is cleaner, but since you are concerned about costs, why not use what you have?

Thanks again from Just Answer.

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