W2 Income Pass Through to S Corp

[nkustura]

I have a client who is sole shareholder of his Scorp. He performed consulting services for a consulting agency during 2014 for which he received W2. Consulting services are in the same line of business as the S corps. The client kept depositing income from W2 into his S corp account, then paid himself wages from S corp. Since the W-2 was issued under his SSN and not S Corp's EIN shouldn't this income be reported on his 1040 and not S corp? It just doens't seem right to me. Any help would be greately appreciated.
Thanks.

[Burke]

Absolutely. If he wanted the income paid to his SCorp, he should have completed a W9 to that effect showing the ID# of the Corporation. There might have even been a contract involved if this had been the case. Apparently, he did not, so he was treated as an employee. W-2 must go on Line 7 of 1040. If it doesn't, he will get an IRS letter for underreporting income. The payor would have withheld FIT, FICA, and SIT on the W-2 income and reported all that to the IRS. The deposits into the SCorp simply mean an increase in his basis on the books. It is not income to the SCorp.

[AccTaxMan]

I have a client who is sole shareholder of his Scorp. He performed consulting services for a consulting agency during 2014 for which he received W2. Consulting services are in the same line of business as the S corps. The client kept depositing income from W2 into his S corp account, then paid himself wages from S corp. Since the W-2 was issued under his SSN and not S Corp's EIN shouldn't this income be reported on his 1040 and not S corp? It just doens't seem right to me. Any help would be greately appreciated.
Thanks.

Troublesome situation. How will he be able to claim the withholding taxes? They are not going to give the credits to his S-corp since the taxes were withheld under his SSN.

[jsamans]

Absolutely. If he wanted the income paid to his SCorp, he should have completed a W9 to that effect showing the ID# of the Corporation. There might have even been a contract involved if this had been the case. Apparently, he did not, so he was treated as an employee. W-2 must go on Line 7 of 1040. If it doesn't, he will get an IRS letter for underreporting income. The payor would have withheld FIT, FICA, and SIT on the W-2 income and reported all that to the IRS. The deposits into the SCorp simply mean an increase in his basis on the books. It is not income to the SCorp.

It's worse than that, isn't it? If he used after-tax income to fund capital contributions to his S-Corp, which used the funds to pay him taxable wages, then he actually needs to issue a W2 for the gross wages paid by the S-Corp and account for a second round of withholding, right?

[Burke]

The deposits into the corporation increased his basis for 2014. Then he paid himself salary out of the corporation, which the SCorp will deduct as an expense. So, if you mean will he have two W-2's to report on his 1040, then YES, that is true. And if the SCorp withheld taxes, he must account for those withholdings on his tax return. He may get a refund. Sounds like due to this situation, he may have a loss in the SCorp to deduct on his 1040, which may offset some or all of this income reported on Line 7. And if there are enough funds in the bank account, he can withdraw the amounts he deposited, which will decrease his basis for 2015, and that gives him non-taxable cash in hand. He will have two W-2's which will count on his Social Security Earnings record for 2014. The wages paid to him out of the SCorp reduce the SCorp income reported on his 1040. So that and the W-2 offset each other. So he isn't paying taxes twice on that income (except for the EE part of SE tax.) Can he qualify for an IRA? There are lots of things to look at and maybe some options which would help him out.

[nkustura]

Thank you

Thank you all for great responses. Would the treatment be any different if the client received 1099 (no employee taxes witheld) instead of W-2. I don't think so since the company issuing 1099 would report this income under his SSN and therefore his tax return wouldn't match the income reported to IRS. Any thoughts?

[jsamans]

Thank you all for great responses. Would the treatment be any different if the client received 1099 (no employee taxes witheld) instead of W-2. I don't think so since the company issuing 1099 would report this income under his SSN and therefore his tax return wouldn't match the income reported to IRS. Any thoughts?

Well, it would be different in that he'd have to pay the full SECA tax on the 1099 income, versus his employer paying half of the FICA tax on the W2 wages. Other than that, no. The real problem lies in his contributing the after-tax income into his S-Corp only to pay it back out to himself as wages, creating an unnecessary layer of tax liability without creating any actual S-Corp income.

[Burke]

Which company are you talking about? The other one who paid him a salary? Or his own SCorp? Did he just write a check and call it "salary?" Did he file and report 941's throughout the year?

[nkustura]

I am talking about the company that gave him W2 for his services. What would happen if they had given him 1099 istead of W2? Thank you!

[Burke]

The real problem lies in his contributing the after-tax income into his S-Corp only to pay it back out to himself as wages, creating an unnecessary layer of tax liability without creating any actual S-Corp income.

This would be a lot bigger problem if it were not a sole-owner SCorp. Since it is, most of this in-and-out will offset itself on the 1040. (i.e, SCorp reportable income passing thru on K-1 is reduced by W-2 on Line 7. It is a wash.) Income tax withholding will be a credit on the 1040. The only thing he is out is the EE tax on the wage income from the SCorp. How much are we talking here?

[Burke]

I am talking about the company that gave him W2 for his services. What would happen if they had given him 1099 istead of W2? Thank you!

He would have had self-employment income on Schedule C and self-employment tax (both halves) to pay on the net, after expenses. But it is too late to worry about that now. It does not change the fact that he deposited funds into the SCorp (which are NOT income) and then paid himself a salary.

[nkustura]

Exactly. Thank you very much for your responses.

[mastertaxguy]

Paychecks for side work deposited to S corp: Additional capital contributions/Loans

1. Is there some reason the scenario described could not be treated as either a loan to the S corp, reducing reporting paperwork on that end, or additional capital contributions to the S Corp?
2. True enough, the SH will have to deal with the third party W-2 on their individual tax return, but it seems to me that treating the deposits of the net paycheck could be treated as additional capital contributions, or loans.
3. This seems to me like a threat we had last week involving a SH who didn't cash his S Corp paycheck from 2013.