Distributions in excess of basis

[Auto]

I know there are a bunch of previous posts on this but I'm still confused.

S corp client took distributions in excess of basis. There was also NO wages taken reported on a W2. Client has a $5000 loan TO the corp on the books. Distributions in excess of basis of $10,000+.

1. Should I just offset the distributions to pay off the loan balance and recognize the rest as capital gains?

2. Or, pay off the loan FROM the shareholder and transfer the balance as a $5000+ loan TO the shareholder? I'm hesitant about showing a loan to the shareholder, a RE of 0, and no officer compensation.

I'm leaning towards #1. All advice would be most welcome.

Thanks.

[BHoffman]

I know there are a bunch of previous posts on this but I'm still confused.

S corp client took distributions in excess of basis. There was also NO wages taken reported on a W2. Client has a $5000 loan TO the corp on the books. Distributions in excess of basis of $10,000+.

1. Should I just offset the distributions to pay off the loan balance and recognize the rest as capital gains?

2. Or, pay off the loan FROM the shareholder and transfer the balance as a $5000+ loan TO the shareholder? I'm hesitant about showing a loan to the shareholder, a RE of 0, and no officer compensation.

I'm leaning towards #1. All advice would be most welcome.

Thanks.

Hi Auto - what was the taxable profit (loss) for the year? If it's a loss, then you don't need to worry about wages. I would go with #1, but others may disagree. I have a thing about loans to shareholders. However, that is a pretty small amount. See what other folks say about this.

[Auto]

made a profit

No, they didn't have a loss. The return is showing $17,000 profit. Their last year 1120S return (not done by me) was pretty interesting. It showed $12,000 in Officer Compensation without any W2 or payroll taxes paid. Then on the personal, a Schedule C was done for the same S Corp business and the $12,000 was shown as income.

[BHoffman]

No, they didn't have a loss. The return is showing $17,000 profit. Their last year 1120S return (not done by me) was pretty interesting. It showed $12,000 in Officer Compensation without any W2 or payroll taxes paid. Then on the personal, a Schedule C was done for the same S Corp business and the $12,000 was shown as income.

They didn't show the SCorp EIN on the Schedule C, did they ?

Here is the hearsay. Others on forums have said their client passed audit with this scenario, indicating that the IRS doesn't pursue if it's on a Sch C or a W2 as long as the client is paying some FICA. Perhaps that was just their particular auditor's take on the thing.

[Auto]

not the same EIN

No. The SS# was used on the Schedule C. I didn' think something like that would ever pass an audit. I know I'm not willing to put it to the test.

[JohnH]

I wouldn't deliberately do that, but at the same time I wouldn't worry about it if I had to help the client in an audit when someone else had done it.

After all, if the auditor made the corp report the payroll, then the taxpayer would be able to amend their personal return & eliminate the S/E tax (income tax would be a wash). The net effect would be a slight positive to the combined taxpayer and corp because the FICA withholding & match would be deductible by the corp and therefore flow through to the taxpayer via the amended K-1, whereas the SE tax us only half deductible on the personal return when reported via the Schedule C. About the only thing the IRS would pick up would be some FTF & FTP penalties on the payroll reports and $56 in FUTA. Any auditor with that much time on his hands needs more substantial work to do. Most of them would let it pass with a hand slap, especially if you can show it isn't a pattern.

[Auto]

very true

Thanks for the reply. You made an excellent point. And, it's not happening this year so it will not be a pattern.
Thanks again.