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I have a California client who did her own corporate tax…

I have a California client...
I have a California client who did her own corporate tax return, I believe because she did not want to pay someone do it. Corporate return has wrongnesses to it. For example, she paid herself 25K just by check, no payroll at all, no W2. And considers this to be business income, and takes some business expenses, e.g. car mileage here. She also pays herself $140 K via K-1. Obviously she should have done W2, but I lack a time machine. Not a lot I can do about it. She is a 1 woman CA S Corp. Should I tell her to 1099 Misc her 25K? Obviously, I need to advise her she needs to pay herself on payroll from S Corp in 2018. Am I in any way at risk in filing her personal tax return based on her faulty S Corp return? Is there anything really that can be done about S Corp return. I do not think it is filed yet, but I have no idea how to fix it in 2018 for what should have been done in 17. I am looking for a practical solution here to goofball situation.
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Answered in 14 minutes by:
3/8/2018
Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 14,628
Experience: Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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Hi. Lane here.

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If this is the first year, IRS is many times lenient about the salary requirement, as it's sometimes difficult to now whether the company will be profitable until after the first yer is out and all the proverbial dust has settled.

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I would just treat the 25,000 as a distribution and take profit through the k-1

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If the S-Corp has been there a while, then you have two options.

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(1) Hope she gets away with it (maybe 2017 is the second year or first FULL year?) OR

(2) give herself a W-2 and use form 8819 to calculate and pay in the Social Security and Medicare which will flow to line 58 of the return.

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If it were me, if there's 25000 there to pay, I'd use option 2, and send in an statement that Client was unaware of the requirement, and that payroll is being established going forward

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Customer reply replied 4 months ago
Dear Lane,
I appreciate your proposed handling. But the client has already DONE his 1120S. It may not be submitted. But it was forwarded to me as if done. My preference is to tell the client her 1120S is BS and opens her up to paying full SS and Medicare. But then do the 1040 return anyway.What is the consequence of having her 1099 Misc herself for 25K? Just take it as a business income? Am I safe it doing a 1040 based on what client did on 1120S? Yes, I know the 1120S is not perfect. But what else can I do? I really cannot go back and pay on W2. Should I just take the 25K as non-1099 business income.If it really makes a difference, I might get client to correct 1120s based on this being part of K-1. My viewpoint is it is goofball either way. So I do not see the advantage of this.Moreover, if IRS looks at return, they are likely to assess Social Security and medicare on full amount up to Social Security limit. This does not particularly worry me, as the client brought it on herself, and can afford to pay it.The client did not want to pay for 1120S. Thinks it is all "simple". If I cannot ethically do a 1040, I could wind up doing nothing and getting paid for nothing.If I can ethically do a 1040 based on client's actual actions in 2017 and his 1120S, am I safe with IRS?I do see the solution of filing the correct W2 that should have been paid, and calcualting SS and medicare and so on. But we are still not able to do it right. So I do not see an immense advantage in this. And argueing with the client on this point could be futile. I can advise her on the consequence of her action in not paying herself on payroll from S Corp. Frankly, I think client wants to takethe chance. What is the consequence to me if I file 1040 here based on what client actually did?

How long has then business been in existence.

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You know me ... I'm fairly conservative and believe that part of any tax person's job is compliance.

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I'd use a 4852 or print out a W-2 and then figure the SS & Medicare on the 8819, thereby treating the 25,000 AS salary.

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About the only way I would EVER file an all k-1 income 1120-S/1040 is if there can be a reasonable argument made that the profit was a complete surprise/1 st yr/ unpredictable /etc.

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What was the actual profit (assuming no salary)?

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Customer reply replied 4 months ago
Dear Lane, Actual profit was about 165k. By putting the 25K in schedule C, I take out a few K in epxense and she pays Soc Security and medicare there. I understand about compliance, but 1) I cannot go back in time to do payroll. 2) She did not issue or pay herself on w-2 3) Going back and paying herself on a salary opens up all the questions as to why no payroll was done. By paying herself on Schedule C, I do not have to prostrate myself or my client before IRS. Also, client had about about 40 K in profit on a real estate transaction, short term capital gain. Client is a real estate pro. Maybe I can make this part of SE income or include it elsewhere in a way she pays SS and Medicare on this. This could put SS and Medicare in reasonable range. What do you think of this concept?

"1) I cannot go back in time to do payroll."

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That's what the 8819 is for ... when payroll wasn't done.

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"2) She did not issue or pay herself on w-2"

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That's what the 4582 is for

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"3) Going back and paying herself on a salary opens up all the questions as to why no payroll was done"

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DO you really think that a 165,000 profit with no payroll isn't already a BRIGHT RED FLAMING flag? It is.

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Bot***** *****ne here is if you don't find a way to pay some Social Security and medicare there WILL be an issue later.

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Just went through an audit with a new client, where we got a no change letter.

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R.O told us that the red flag was that this was an LLC/partnership where the owner had been paying himself a W-2 ... and that typically means all kinds of other things are that completely messed up... but becasue he had always paid himself at the wage base, (hence no taxes were evaded - AND there were no OTHER problems) we got no tax due with the direction to stop the salary going forward.

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Different situation, but same underlying issue; they couldn't find more tax revenue OR anything else that they thought they'd find.

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Sounds like this one might just be the opposite - escaping LOTS of SS & Medicare (and possibly LOTS more to uncover if audited?"

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Whatever you do, I'd find a way to get the SS & Medicare up to what would be reasonable for an officer in an S-Corp that had 165K of profit

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Sorry for not giving you an easy answer, but this is my honest perception of the issues. There ARE ways to fix this. That's what I would do.

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If you want to take the other path, I'd recommend that you document that you have refused any gift, favor, or hospitality that would influence or appear to influence your actions in this case. *

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And be prepared to show that there is substantial authority that the position will be sustained on its merits, OR that you DISCLOSE on a statement that there is at least a reasonable basis for it. **

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And that you have explained to your client (you might want to send certified mail) the probable effects of various alternatives (If applicable law is unsettled, or the application of law to the facts in a given situation is uncertain) in this letter, and that it is the client who makes the final decision as to the position taken. **

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*,** If you do that, you'll have the Rules of professional conduct to point to in your defense (see rules 7 and 8).

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Customer reply replied 4 months ago
OK. How about if I fix it by taking 1099 income as self employment income and pay SS and Medicare on it? Is this a legit fix, or is him paying himself by 1099 absolutely illegal.I am quite willing to drop the client. He did a corporate return and did not do payroll. If I do a 1040 based on his corporate income, and at least put in signifcant SE income, would this be legit. I could even do his SE icome up to the 128 K, in extremis. Suppose I put in a reasonable compensation and take it as 1099 as it is after the fact. Am I risking my professional status by so doing?Sounds like you think I am. If I were to take say 70K as net schedule C 1099 comp, the IRS would get a lot more than what client would want to do. Sounds like you think this is very risky, right?Would taking 120K as SE comp also be very risky?I would like to tell the client "If you want me to file return, you have to pay blank to yourself and pay SS on it. " Would this be a legit solution?

"OK. How about if I fix it by taking 1099 income as self employment income and pay SS and Medicare on it? Is this a legit fix, or is him paying himself by 1099 absolutely illegal."

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It's not appropriate BUT, just as with my recent case, it gives the collections division of the IRS (the division we deal with every day, until something goes to appeals)m what they want - tax revenue.

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"I am quite willing to drop the client. He did a corporate return and did not do payroll. If I do a 1040 based on his corporate income, and at least put in signifcant SE income, would this be legit. I could even do his SE icome up to the 128 K, in extremis. Suppose I put in a reasonable compensation and take it as 1099 as it is after the fact. Am I risking my professional status by so doing?"

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No I think that an attached statement that says you're doing this in an attempt to rectify the client's trying to get away with - you could word it more softly - paying no SS & Medicare, when the 1120 was prepared by the client without your input actually enhances your professional position ... and would show that you get it ... that the objective of the required salary (the substance over the form) is to pay social security and medicare at a reasonable level.

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If this isn't an educated person, and couldn't earn at the wage base as an employee of someone else, then going to that level may be overkill - but but 25K, in my opinion, is unreasonable in the other direction (with taxable profit of 165K).

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Not knowing more about the facts and circumstances, I would that 70 is a good happy medium.

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"I would like to tell the client "If you want me to file return, you have to pay blank to yourself and pay SS on it. " Would this be a legit solution?"

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Yep ... it would be the right thing to do, in my opinion

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Customer reply replied 4 months ago
The client has decided to pay herself 62k for 2017 as a 1099 misc and the other 200k profit will come to her as K1. She will do a proper payroll in 2018. She will pay Soc Sec and Medicare on her SE income. Would you agree that, based on this, I would be safe in filing the return? I will have also advised the client she SHOULD have done W-2 in 17.

Yes.

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I'd appreciate a positive rating (using the stars on your screen, and then clicking “submit")

Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 14,628
Experience: Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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