S-Corp Extension, New Corp, Problems

[geekgirldany]

New client comes to me with 2012 and 2013 tax returns to be prepared. Personal and business. Former accountant had 2012 since last year and he gave him 2013 in January 2014. Accountant calls and tells client that he is quitting and gave client back the majority of the information, some is missing. Client said other accountant talked about making the business an S-Corp (formed with state as LLC), but he did not file Form 2553 and the client does not recall signing it. Client also said accountant mentioned Schedule C. I am not sure what happened or how the business was to be filed as I am relying on the client's end of the conversation.

The business is extremely profitable, over 1 million in sales, so it really does need to be an S-Corp. Client took distributions, no payroll and business has been run completely separate, no personal expenses mingled in, so I've been told.

I thought I would try to file an extension for the business as an S-Corp with the chance that Form 2553 was filed. Well it came back rejected.

First question, can a Form 2553 still be filed for the S-Corp election in 2012 through Revenue Procedure 2013-13? Since part of the requirement for late election is that income was reported as if the election was requested... I am not sure.

Can the client mail the Form 7009 for TY 2013 and it be accepted by the IRS? She will owe a large enough penalty for 2012 so I would like to cover 2013.

It has occurred to me to possible file Schedule C for 2012 and then do an SCorp for 2013. I do not have all the paperwork yet so I am unsure tax wise what an effect this would have.

Thank you for any help
D

[JohnH]

I'll jump in here. I think you probably need to stick with Disregarded Entity (Schedule C), for 2012 and 2013. But if the client wants to convert to S-corp, you need to file the 2553 for 2014 by March 15 (next weekend). I assume the date defaults to March 17 this year, but I don't know for sure.

I think the major thing the client will lose is having to make SEP contributions (if she chooses to do them), from money which has been subject to S/E tax as a sole proprietor. (An S-corp contribution to a SEP comes out of funds before Social Security/Medicare tax, so it's 15% more tax efficient). Other than that, I don't see much difference. On the other hand, you will avoid potential problems with reasonable salary questions on those prior years.

Maybe others will jump in here and correct me if I'm wrong.

[TXEA]

I would agree with JohnH. I would file a Schedule C for 2012 and 2013 especially in light of the fact that no payroll was made to the owner. All distributions would not fly for a second upon review. Further, filing late employment tax returns to try and reclassify the proper amount of salary would be cost prohibitive with penalties.

File the S election next week for 2014 if the taxpayer so chooses.

[geekgirldany]

Thank you both for responding.

I believe it would be the best also. More than likely the accountant was going to do 2012 as Schedule C and then set up as a S-Corp for 2013. Do not know though.

I've prepared S-Corps where the first year there was no payroll and made the election for S-Corp treatment, with insistence that they must start payroll the following year. With what the client has said he has drawn out of the business for himself, I believe the distributions would just look too funny two years in a row with no payroll.

Unfortunately, like I said this is an million dollar business and the client will be paying so much in SE Tax as expenses are low.

Thank you all again.

[JohnH]

Well, the S/E tax won't be much more than the SocSec/Medicare after all the dust settles. With the client being the sole owner, any matching SocSec/Med amounts paid by the corp are really coming out of funds owned by her via net cash in the corp.

With the business being as profitable as you say, the client would probably max out on SocSec wages anyhow, so the only savings with an S corp would be the Medicare tax & matching amount on the S-corp earnings which were not shown as wages. Looks like the most important thing for the client to do though, is max out on his retirement plan (probably a SEP) in order to achieve some reduction in the income tax liability.