Shareholder gives 1099 Misc to himself?

[tacks]

I have a corporate client [edit: S Corp] who made the mistake of not giving salaries to shareholders. They are a daycare center for low income families -- they receive state subsidies.

Would issuing a 1099-Misc to one of the shareholders for a modest amount throw up a flag? He did do a lot of renovations that the other shareholders did not do. He did take the money out. And it would give him an EIC.

(i know that we'd be filing the 1099s late -- possibly a late fee)

thanks in advance

[JohnH]

Somebody (on another forum, I believe) said they have issued 1099's in this situation before and reported the amount as "Officer Salaries" on the corp return, provided the client agreed to get in line and do it right going forward. As long as the S/E income is reported, about the only thing the IRS is missing would be the FUTA. Of course, there could be SUTA problems if the state go hold of it. Regardless of whether it's a C-corp or an S-corp, the net result would be about the same. I was a little surprised by that treatment since I thought the Wages lines were compared to 941 filings at some point, but maybe it isn't an issue.

If it's a C-corp, there's also the possibility of reporting the payments as a constructive dividend. Net tax cost is about the same because the C-corp would pay 15% income tax on the dividends, which is roughly the net cost to the sole shareholder of the FICA and matching FICA on wage payments. But in that case the client would lose the benefit of the EIC.

I'm betting you'd never see a late-filing fee for the 1099, but that's just speculation.

[tacks]

Thanks John,

It's an S Corp -- I should've specified.

I would NOT report salaries (officers or not) that weren't included in to the 941s & w-3. I would have the shareholder report it as self employment income on his 1040.

These people kept horrible records and i would not want them audited. Hence i do not want to throw up flags.

[They are, by the way, taking all my advice as to how to get straightend out going forward.]

"I'm betting you'd never see a late-filing fee for the 1099, but that's just speculation."

That's also what i'm guessing. But that'd be the least of their problems.

It's looking like 1099ing the shareholder is the way to go.

thanks again

[tacks]

Anyone else have thoughts on this? I'd be all ears.

thanks

[JohnH]

The dilemma is, that by filing an 1120S with no officer salaries being reported, you may be running up a red flag anyhow.

[geekgirldany]

I've never done this but I've seen several returns from new clients where the preparer did a 1099, put it as Officer Salaries on S-Corp, and then report it on Schedule C. I talked to one of the the accountants that prepared the return. He said he had always done it that way when the client would not come to him during the year. It was the only way he could get the SS tax paid in.

[tacks]

The dilemma is, that by filing an 1120S with no officer salaries being reported, you may be running up a red flag anyhow.

I totally agree. And i've already brought that up. [edit: brought it up with the client]

But

1 that occured before my watch -- so i don't feel responsible. The corp will recognize interest income for any $$$ loaned to shareholders

2 if they do get pulled, i'm hoping that the IRS will recognize that the SE was paid on the personal level and it is, for the most part, a wash -- like you mentioned.

3 it will be a flag, but a far smaller flag than i've seen on other return prepared by others

thanks

[tacks]

Hi Dany,

Thanks for posting. I'll reply in the morning.

Jim

[BHoffman]

And it would give him an EIC.

Schedule C with EIC is, IMO, a red flag for audit.

[tacks]

Hi Dany,

Thanks for posting.

As i was saying to John would never deduct salaries from a corp return that were not included in w-3 totals -- especially not with this client.

[tacks]

Hi BHoffman,

Schedule C with EIC is, IMO, a red flag for audit.

Yes, i see your point. But how much of a flag would it be if Sch C net income was exactly equal to the 1099-Misc Income?

I'm not terribly concerned with the shareholder himself getting audited so much as i am concerned with the corp getting audited. But then again an audit of the shareholder would draw IRS attention to the corp.

[JohnH]

Just for grins, roughly how much Schedule C income are we talking about and how much EIC, along with how much S-Corp net profit with and without the 1099?

(I'm thinking about the relative benefit to the client vs your fees for the work, weighed against the risks to client and preparer associated with EIC problems.)

There are many times with a C-corp when it's better to report things exactly as they are - show the corp net profit and show the constructive dividends on the personal return, simply because that's what really happened.

Maybe there are times when it's prudent to do the same thing with an S-corp by just showing it all as S-corp distributions. You're running some risk of the S-corp being tagged for showing no officer salary, but in fact that is what happened. By foregoing all the shenanigans and having the client come into compliance in the following year, you have a pretty strong position if either the client or the corp is audited. On the other hand, if IRS takes a look at it and decides to make changes, you have the EIC there on the personal side to offset any penalties & interest the corp may pay on the unreported salaries. With a sole shareholder S-corp, it's all the same money in the end regardless of which bucket it comes out of or goes into. Just a thought...

[luke]

interesting discussion

I for one would NOT file 1099-misc and show as SE income on personal tax return - it MAY look to IRS as though it was done to get EIC! ? With new due diligence/scrutiny of EIC I would simply report everything as it was given to you (if that raises red flag its still better than "fraudulently" obtaining EIC?) I'm NOT suggesting that YOU would be committing fraud but I was saying that IRS MAY consider that EIC in this instance is not "kosher"?

[tacks]

Sure John,

But keep in mind that everything is still up in the air at this point. I don't yet have firm numbers (not even the age of the shareholder's kids)

But w/ k-1 income of 28,000
& shc C income of 5,000
the shareholder might receive roughly 288 of schedule M credit
and 1,615 of EIC

Whereas if there were no Sch C income then k-1 income would increase to 30,500 -- there would be no EIC, no Sch M, and taxable income would increase.

The Net difference between the two scenarios would be roughly $1,350 in tax/refund owed.

[tacks]

Just for grins, roughly how much Schedule C income... EIC, S-Corp net profit...

(I'm thinking about the relative benefit to the client vs your fees.... ) .

My initial thought is that since he's going to pay me for the 1120 S and the 1040 i might as well take advantage of all legitmate tax benefits available.

But as you mention maybe there's audit risk involved with EIC and S Corp w/ no officer's salary.

...if IRS takes a look at it and decides to make changes, you have the EIC there on the personal side to offset any penalties & interest the corp may pay on the unreported salaries.

perhaps i might opt to compromise -- 2500 in Sch C income instead of 5000.