rewarding employee for business expansion

[kathyc2]

S-corp has been in business 30 years or so. Shareholders are husband and wife. His son started working in business 15 years or so ago. Son had idea of selling products on-line and was instrumental in getting it going. Currently, this part of business accounts for 90% or so of business. Son is one who knows how to run this part and controls access with such things as passwords.

Family dynamics come into play. Son keeps demanding more pay. Step-mother had concerns that son could just "take" that part of business. I don't disagree with her that he might do that, but I doubt he has capital for inventory.

Attorney suggested they pay the son for the rights he may have, and they wrote him a large bonus paycheck in 2016. I have no problem with that, but now father is saying that he wants to reclassify that payment to be non-payroll.

Obviously, 2016 payroll reports have all been filed. If it was backed out of payroll, a 1099 would need to be issued, and I would think it would need to go in box 7.

Does anyone know of a loophole that son would be allowed some special kind of tax treatment if the payment would be on 1099 instead of W-2?

[ATSMAN]

S-corp has been in business 30 years or so. Shareholders are husband and wife. His son started working in business 15 years or so ago. Son had idea of selling products on-line and was instrumental in getting it going. Currently, this part of business accounts for 90% or so of business. Son is one who knows how to run this part and controls access with such things as passwords.

Family dynamics come into play. Son keeps demanding more pay. Step-mother had concerns that son could just "take" that part of business. I don't disagree with her that he might do that, but I doubt he has capital for inventory.

Attorney suggested they pay the son for the rights he may have, and they wrote him a large bonus paycheck in 2016. I have no problem with that, but now father is saying that he wants to reclassify that payment to be non-payroll.

Obviously, 2016 payroll reports have all been filed. If it was backed out of payroll, a 1099 would need to be issued, and I would think it would need to go in box 7.

Does anyone know of a loophole that son would be allowed some special kind of tax treatment if the payment would be on 1099 instead of W-2?

Proceed with caution. I am assuming that son has no equity interest in the business? He is a W2 employee. If you back out of payroll, the business could structure it as Royalty payment and that avoids SE taxes that comes with box 7 1099-Misc.

[Burke]

Also, make sure that treatment is recorded and documented in the S-Corp's minutes and authorized by those officers. May need a separate resolution approved by the board.

[spanel]

S-corp has been in business 30 years or so. Shareholders are husband and wife. His son started working in business 15 years or so ago. Son had idea of selling products on-line and was instrumental in getting it going. Currently, this part of business accounts for 90% or so of business. Son is one who knows how to run this part and controls access with such things as passwords.

Family dynamics come into play. Son keeps demanding more pay. Step-mother had concerns that son could just "take" that part of business. I don't disagree with her that he might do that, but I doubt he has capital for inventory.

Attorney suggested they pay the son for the rights he may have, and they wrote him a large bonus paycheck in 2016. I have no problem with that, but now father is saying that he wants to reclassify that payment to be non-payroll.

Obviously, 2016 payroll reports have all been filed. If it was backed out of payroll, a 1099 would need to be issued, and I would think it would need to go in box 7.

Does anyone know of a loophole that son would be allowed some special kind of tax treatment if the payment would be on 1099 instead of W-2?

Giving an "employee" a 1099 is always sticky situation as it appears the employer is trying to get out of ss/med/workcomp/unemployment payments.

Also, sticking the employee with these taxes isn't going to make this situation any better, it anything it will make it worse.

Chris

[kathyc2]

Giving an "employee" a 1099 is always sticky situation as it appears the employer is trying to get out of ss/med/workcomp/unemployment payments.

Also, sticking the employee with these taxes isn't going to make this situation any better, it anything it will make it worse.

Chris

Believe me, I'm not wanting to do this. Son's W-2 already met the SS limit before the bonus, so all we are talking about is Medicare. Meeting with client tomorrow and if he insists on doing it, I'll have him sign off that doing so is against my advise.

Burke, I won't get involved w/ corp minutes. I made sure they talked w/ attorney that maintains corp minutes.

Does anyone disagree that it should go to box 7 if they insist on backing it out of payroll?

[spanel]

Believe me, I'm not wanting to do this. Son's W-2 already met the SS limit before the bonus, so all we are talking about is Medicare. Meeting with client tomorrow and if he insists on doing it, I'll have him sign off that doing so is against my advise.

Burke, I won't get involved w/ corp minutes. I made sure they talked w/ attorney that maintains corp minutes.

Does anyone disagree that it should go to box 7 if they insist on backing it out of payroll?

Box 7 is my vote. Again, how is this going to make the situation between Father/Son any better?!?

You'll have to amend Fed & State 941/Fed 940/Unemployment/W2,W3 and File 1099/1096.

Make sure you charge handsomely for this.

How much are we talking as your fees make make this a mute point?

Chris

[kathyc2]

Uggghhhh!

Now Dad e-mails me and said he misunderstood attorney and payment would be for covenant not to compete. Wouldn't that make it a 197 intangible amortized over 180 months? Wouldn't there still need to be a 1099 box 3 issued to son?

[spanel]

Now Dad e-mails me and said he misunderstood attorney and payment would be for covenant not to compete. Wouldn't that make it a 197 intangible amortized over 180 months? Wouldn't there still need to be a 1099 box 3 issued to son?

I still think it should be on a w2 if its a non compete payment as he is an employee and not purchasing anything from his dad, nor did he "sell" anything to his dad.

If you go the route of that, yes it would be amortized over 15 years. (I'm sure dad wont like that.)

With pretty much all non competes that employees sign, their incentive is a. the job b. a bonus that is taxable on a w2 subject to all withholdings.
(which you already did).

I'm still saying dont change anything.

Chris

[Burke]

#1: I would not change it from payroll to 1099, Box 7 without proper documents. They would have to have an independent contractor agreement on file to do this, and I would want to see a copy. How long ago was this "bonus" paid?

#2: A Covenant-not-to Compete arrangement would require a document signed by both parties to make it legal. I would also want to have a copy of it to change this. Have him get one from the attorney. If, under these circumstances he is still going to continue doing what he was before, only on his own, it could be a violation of any CNTC agreement, in my opinion. Is he going to go away as a result of this payment? I am not sure 1099MISC, Box 7 is the way to handle this. To me it looks like a sale of an asset, and 8594 is involved by both parties. I am unable to find anything definitive involving a CNTC which doesn't involve the sale of an entire business.

[Roland Slugg]

Royalty? For what? Reclassify to a 1099? For compensation paid to an employee? Get real. Non-compete covenant? After the fact? For an existing employee? All that plus advice telling you to be sure to charge a stiff fee for all your extra work ... as if you wouldn't think of that yourself.

Payments to an employee are compensation unless they are payments for an asset the company bought from that employee. What is the son selling? Sounds more like bribery to me. "Pay me, or I'll pirate the online division of the business, take it with me, and I won't tell you what the passwords are!" Does somebody see a tax benefit here somehow? The son? The parents? The lawyer? The man in the moon? As far as what they're trying to accomplish, I'm clueless.

In many cases a CNTC made between employers and employees (as opposed to buyers and sellers of a business) is unenforceable except in limited situations and industries. In California, and perhaps other states as well, they are unenforceable by state law.

[kathyc2]

Royalty? For what? Reclassify to a 1099? For compensation paid to an employee? Get real. Non-compete covenant? After the fact? For an existing employee? All that plus advice telling you to be sure to charge a stiff fee for all your extra work ... as if you wouldn't think of that yourself.

Payments to an employee are compensation unless they are payments for an asset the company bought from that employee. What is the son selling? Sounds more like bribery to me. "Pay me, or I'll pirate the online division of the business, take it with me, and I won't tell you what the passwords are!" Does somebody see a tax benefit here somehow? The son? The parents? The lawyer? The man in the moon? As far as what they're trying to accomplish, I'm clueless.

In many cases a CNTC made between employers and employees (as opposed to buyers and sellers of a business) is unenforceable except in limited situations and industries. In California, and perhaps other states as well, they are unenforceable by state law.

I totally agree that trying to get it out of payroll makes no sense. This client is constantly coming up with hair-brained ideas. Just threw it out there in case there was some obscure part of the tax code that I was not familiar with. With several of the more knowledgeable posters agreeing that it doesn't make sense, I feel much more confident in telling him it doesn't make sense. Thanks all!!!

[spanel]

I totally agree that trying to get it out of payroll makes no sense. This client is constantly coming up with hair-brained ideas. Just threw it out there in case there was some obscure part of the tax code that I was not familiar with. With several of the more knowledgeable posters agreeing that it doesn't make sense, I feel much more confident in telling him it doesn't make sense. Thanks all!!!

At the end of the day the client is saving 1.45% of the medicare match. Again how much are they "saving" after they add back your fee?

I think everyone here is on the same page, it is a bonus and is taxable on the w2.

Chris