seperate entity?

[tacks]

A daycare center is a corp with two shareholders, equal ownership, 50/50. The shareholders used corp funds to start a beauty salon which flopped.

Solution: create a 50/50 partnership for the beauty salon report the beauty saolon seperately. Record distributions to shareholders and/or shareolder loans in corporation.

Sound OK? Any thoughts?

My thought is that i don't want to show such high expenses in the Daycare because it would look questionable to the IRS.

[Lion]

What really happened?

What really happened? Did the CORPORATION run a beauty salon? Did the shareholders take distributions &/or loans and form a partnership and run a beauty salon?

[tacks]

What really happened? Did the CORPORATION run a beauty salon? Did the shareholders take distributions &/or loans and form a partnership and run a beauty salon?

What i just told you is what really happened. I highly doubt that these people were being dishonest with me.

The shareholders did indeed open a beauty salon. And they have receipts and/or cancelled checks (or so they claim). They did take distributions and/or loans from the daycare corp.

It wasn't the the corp running it, IMO. Rather it was the shareholders using corp funds to support an entirely different entity, different location, different employees and a different industry.

Again, record the beauty salon seperately in a partnershipt. Right?

[Lion]

corp funds

If corporate funds supported the beauty salon, then the corporation reports it. If the individuals funded the beauty salon, then the individuals report it. If the individuals formed a partnership which ran the beauty salon, then the partnership reports it. If the individuals formed a new corporation....

"The shareholders used corp funds to start a beauty salon which flopped."

Or, " They did take distributions and/or loans from the daycare corp."

[tacks]

If corporate funds supported the beauty salon, then the corporation reports it. If the individuals funded the beauty salon, then the individuals report it.

"The shareholders used corp funds to start a beauty salon which flopped."

Or, " They did take distributions and/or loans from the daycare corp."

What if it's been a bit of both?

Anyhow i'm leaning on making the beauty saolon a seperate entitiy.

[Gary2]

I don't see how it's possible to say that "shareholders used corporate funds."

One possibility is that they took a distribution, in which case it's no longer corporate funds, it's their funds.

Another, assuming the corporate charter permits it, is that the board of directors voted to invest a given a mount in the new enterprise, in which case the shareholders didn't use corporate funds, the corporation used corporate funds. The corporate minutes would reflect this.

Yet another, with similar assumptions, is that an officer or employee had the authority to make such an investment and did so. In that case, it's still the corporation using corporate funds. Again, there would be a record showing that the individual had been granted such authority.

I'm guessing that none of the corporate records for tracking this down exist, and I don't know if it's legal for the corporation to ratify such actions after the fact. But before worrying about that, first check whether the charter even allows them to enter into an unrelated business. I wouldn't be shocked if the answer were no, in which case you're stuck with the "distributions were taken, the corporation has no connection to this" path.

[JohnH]

Did the beauty salon have a separate checking account? If so, was it established as a corporate account, partnership account, etc? What was the name of the entity on the checks? ( for example, was it "xyz Corp d/b/a abc beauty shop). Did it sign a lease or any other contracts with suppliers, equipment leasing companies, or independent contractors? How did the business represent itself to the public and its business associates? Did it have business cards - what name was on them?

Gary has a great point about the permitted activities of the Corp. You should look at the charter to determine if it has a "general statement of purpose" rather than a narrowly-defined purpose for which it was oranized. Sometimes defects of this type can be easily cured after the fact, but in other cases it's not so easy.

I think you need to look at some specifics concerning how the business was actually operated rather than focusing on how it "might look" on the corporate tax return or what the tax outcome might actually be. I'd rather prepare a funny-looking accurate return than to fudge things and get an outcome that might leave me responsible for twisting the facts.

[tacks]

Thanks all.

Appreciate the feedback. But this corp is very mom and pop. I'd be surprised if they'd ever even heard of a corporate charter.

These people are very new in being self employed and i've been cleaning up the resulting messes for some time now.

[Gary2]

They can't have a corporation without a charter. At least I've never heard of a state that would allow a formation of a corporation without a requirement that the business purpose be stated in the documents.

Or are they really a partnership that has chosen to be taxed as if they were an S corp (which isn't the same thing as actually being an S corp).

[JohnH]

I agree. If there's no charter then there's no corporation. Even if it's an LLC choosing to be taxed as a corporation, there must be Articles of Organization filed with the Sec of State, which is roughly the equivalent of a corporate charter. Absent either of those filings, if they're just a sole proprietorship or informal partnership pretending to be a Corp, then they could have other problems not related to their taxes.

[oceanlovin'ea]

from the original post, I would say that the 2 individuals took distributions from the corporation. (I do agree that you should make sure that they are set up with the state as a corporation or an LLC and that they have filed to be taxed as an s corporation with the IRS. )

When they took the distributions, the money was theirs and they could do what they wanted with it.....go on vacation or save it or invest in a beauty shop.

That would make the beauty shop another business totally owned by the individuals not the daycare.
If they made no provision to set up the beauty salon as an LLC or corporation, they would have to default to a partnership.

You would end up with 2 business returns and they would each get 2 K-1's to go with their personal returns.

You should instruct them to make NO business decisions until they have talked with you first regarding tax consequences and tax strategies.

Linda, EA

[JohnH]

---> You should instruct them to make NO business decisions until they have talked with you first regarding tax consequences and tax strategies. <----

What?
Why would anyone do THAT?

Linda, I swear you're clearly trying to take all the fun out of this business...

[Lion]

Both?

"What if it's been a bit of both?"

Then you have three participants -- the corp, individual 1, and individual 2 -- operating a new business as a (partnership? joint venture? new corporation?) Pick one that fits reality. Did the new company organize with the secretary of state? Are they all 33 1/3 members?

You have lots of questions to ask your clients. Ask them for ALL paperwork. Papers opening checking accounts, for instance, probably include a corporate resolution. Around here, beauty salons are regulated by the Health Dept., so paperwork would exist giving the salon permits, etc.

[tacks]

Thanks again, all. Great stuff that i never needed to look at before. I appreciate the education.

Hi Linda,

Thanks for responding.

Your leaning towards having a seperate business entity is the way i was also going. It's like when your client uses Corp funds to pay for personal expense -- you reclass the expense to be a shareholder loan or shrhldr distrbtn.


Linda & everyone else,

As these two 50/50 shareholders are a couple who live together and have children together I don't see the why i need to look at this so closely. (granted i could be way wrong, i don't normally get involved in this part)

What's the danger of not looking closely at the corp charter, the beauty salon's license, how the salon was operated, etc? Honestly i'm not sure.

MY thoughts (which might well be flawed) is merely that the IRS would want all income reported and all that NO expenses are counted twice. Meaning that an expense can either be on one business or the other business -- NOT both.

Why would i need be concerned about anything else?

Might this become a problem later down the road if the couple splits up?

It is indeed a corporation. I successfully elected S status, effective tax year 2009.

You should instruct them to make NO business decisions until they have talked with you first regarding tax consequences and tax strategies.

Linda, EA

I can instruct them but i don't expect that it'll necessarily mean anything to them. I bought them Quickbooks software and installed it last September. Suggested they hire a bookeeper who was QB literate. When they gave their QB file in April i saw that it had 28K dollars worth of the 620K dollars worth of transactions shown on the BK statement.

Tacks

[JohnH]

The fact that you filed a 2553 sucessfully is almost irrelevant to the questions you're asking and the ones you're being asked in this thread. It certainly doesn't prove this is a corporation. As a matter of fact it may point out a big problem you need to address.

You can do things how you want, but I would NEVER file a 2553 until I've seen the corporate charter, minutes book, and shareholder registry. You need to see those documents in order to properly fill out the 2553. The 2553 can sail through with completely wrong information because IRS doesn't bother to verify anything about the existence of the corp itself, or about the shareholders interests. They will hold the person who prepared it responsible for the accuracy of the information it contains. When a potential client contacts me and says they're a corporation, the very first thing I do is look them up on the Sec of State web site, usually while we're still talking on the phone. It's often amazing how little people really know about their legal status.

I'm probably overstating the case, but you really DO need to look at everything closely. In the least-worst scenario you're just building up a bigger mess, but under the worst-case scenario you could be unintentionally perpetuating a fraud. Not saying that's what you're doing, but you're leaving yourself open to that sort of accusation if things should ever go south with this client.