Small C Corp started in 2004, wrote checks to president, and his wife and children, and paid personal expenses. I can't find requirement for any of this to be wages. Do I enter it as distributions? No returns ever filed for corporation, didn't register with state as employer.
It sounds like dividends to me, and I assume IRS would classify it as such. I know what an S-Corp distribution is, but I don't know what C-Corp distribution is.
Not sure how you enter div's in corp program. Maybe you don't. Maybe it simply lowers the retained earnings and that's all you have to do.
In a C corp, distributions would be equivalent to dividends which is something you normally avoid in a small business setting.
Loans to shareholders can be loans if there are real notes and real payments made on them.
It sounds like this shareholder depends on the income of the corporation for personal living expenses, and if services are being provided then the payments should be classified as compensation.
One danger in this situation is that the year of the cash flow becomes detached from the year that cash is needed to pay income tax, and clients generally can't understand why they owe tax now on money they aren't getting.
Scott
It would be entered as distributions on the corporate return and a 1099-DIV should be issued for the amounts distributed. The corporation does not receive a deduction for the distribution of dividends paid.
That is the only way besides wages to take money out of a C-Corp. This is what is meant by double taxation. The earnings of the corp are taxed at the corporate level and when the earnings are distributed they are taxed again at the individual level.
At least currently after 2002, such dividends are taxed at a low rate rather than one's normal marginal rate. But it is still taxed to both the distributing corporation and the individual shareholder, so it is still "double taxation" -- just not as high as the tax used to be before 2003.
I have a C-Corp client where he is the sole shareholder. He pays himself a salary every year, with the goal being to zero out the C-Corps income. Since his cash flow is sufficient, we report a periodic salary, but he withdraws money as needed for personal expenses. At the end of the year, any excess money that he withdrew, is treated as a consultants fee. We do not classify it as a dividend, hence, avoiding the double taxation issue.
It is certainly a delicate balance between additional SE Tax and double taxation, but, since we do both returns, we are able to make it work to his benefit. In other words, we are able to maximize his total tax savings between his business and personal returns.
I would have liked to make the distributions wages, but the 941, etc. penalties would be huge.
Would the IRS have a problem with all of his income being dividends? Seems as if they would like to see some FICA.
I'm sure IRS would like to see some FICA. This business of distributions rather than wages, has been a sore point with IRS and S-Corps for years. With C-Corps, perhaps IRS has the same problem but not quite as much so as with S-Corps.
Your client may have a problem, and it looks as if solving it for what happened in the past, may be tricky or expensive, but going forward, you can set them up with a payroll schedule and point out how they can stay out of trouble from 2008 on. Whatever you do for past years, you probably should point out to the client to keep their fingers crossed but not be surprised if IRS comes back and takes issue with whatever they did.
This is such a shame when people "do their own thing" and don't come to an accountant until much later. At least they came to you now -- better late than never.
Not only would I verbally explain the potential for IRS examination, put it in writing as well. Cover yourself by presenting the client with a written statement of potential tax liability.
IMHO anyway.
At this late stage, you definitely don't want to treat it as wages. You're right, the penalties aren't worth it. However, you might consider treating it as outside consulting fees paid. This way, the IRS gets their FICA, the C-Corp. gets a deduction, and the element of double taxation is avoided.
Personally, I think treating it as dividends is the one treatment you want to avoid, if possible.
I did this one year for a client who also used C-Corp to pay personal expenses. At Corp year end we converted some to salary (and paid payroll tax penalties) and the rest was 1099-Misc as a consultant.
Upon review by another CPA, client was advised that this is not the proper way to record money paid to shareholders, especially Corps w/one or two major shareholders. Was also advised this could be subject to IRS audit and them disaalowing, converting to salary and incurring huge penalties.
I've also heard that C-Corps where the shareholder uses the funds for personal use are highly subject to audit and if reviewed the IRS can revoke your Corp status deeming the shareholder is basically using for personal use and thus should be a sole-prop.
I'm facing the same problem again this year w/client spending huge amounts of money on personal exps in addition to taking a salary. I hesitate on doing the 1099 again. Any suggestions here? Does anyone know the tax law regarding this type of situation? I am sure it's quite common!
I think there have been a few stories in the news about corporate executives paying huge amounts of personal expense out of corporate money, like Dennis Kozlowski. When you work for the company, you take a salary. How hard is that for people to understand? It's not YOUR money!
But also beware of too much compensation, which the IRS can then re-classify as dividends.
And you cannot be both a W2 employee and a 1099 consultant for the same company. That will lead to an audit, which will probably result in reclassifying dividends, which gives them double-taxation. Pigs get fat, hogs get slaughtered.
From Internal Revenue Manual:
1. Corporate officers are specifically included within the definition of an employee under FICA, FUTA, and for federal income tax withholding purposes. http://www.irs.gov/irm/part4/c...
There's also some consideration of capital invested to support payment of dividends.
Penalties are lower if employee misclassified and 1099 issued than if no reporting at all.
Issuing a 1099 and running SECA on Sch C sounds like the lower-penalty route for 2004/2005/2006/2007 returns, but sounds like it runs risk of audit.
I believe the key point may be whether the shareholder performs services; then the question will be, is the shareholder an employee or a consultant? This would be determined by facts and circumstances.
If the wife and kids perform services, they could be employees, too; however, if they don't, any payments to them or for personal expenses of the shareholder would seem to be dividends.
Reasonable compensation may also be an issue. If the shareholder does perform services for the corporation, making compensation much too low or too high can lead to reclassification of dividends as wages, or vice versa.
This is very similar to the challenge of qualified personal service corporations.
The best answer is to keep up with the bookwork, and be ready to finalize things in time to file the required payroll tax reports in a timely fashion.
Scott
