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Old 01-14-2013, 03:10 PM
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Have not filed an 1120 for the last 3 years.

Hello,

I am helping a friend with his bookkeeping and notice that he is a c-corp. However when examining his personal tax returns, the person who did them, filed a schedule c, as if he was a sole prop. He has not gotten any notices from the IRS yet but I'm afraid he might owe lots of money in penalties and interest.

He has been paying himself as draws from the business.

I am assuming that we need to do the 1120 tax returns for the last 3 years, and the amend the 1040 tax returns for the same years as well.

We are in the state of WA if that matters so no state income tax.

I have set him up on payroll now to take a decent salary and he is exempt from L&I workers comp and unemployment security (managed by WA state). we will taking more money for the federal unemployment taxes.

Any other thoughts on how to proceed from here? things to consider? would I have to create W-2s for all those years he paid himself as a draw? would we need to submit 940s for those and pay taxes and penalties?

Thanks



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Old 01-16-2013, 04:08 AM
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“the person who did them, filed a schedule c, as if he was a sole prop. He has not gotten any notices from the IRS yet but I'm afraid he might owe lots of money in penalties and interest.”===> I guess his tax accountant may have treated his C corp as SMLLC/sole proprietor since he/she didn’t know that your friend incorporated his biz as a C corp. I mean as long as he is a SMLLC owner(not setup to be taxed as a C Corp.), then no W-2 should have been prepared in this case.

“He has been paying himself as draws from the business.I am assuming that we need to do the 1120 tax returns for the last 3 years, and the amend the 1040 tax returns for the same years as well.”========> C" corp can't take a draw. It is essentially a dividend if not taken as payroll on W2. (Draws" are terms that apply to partnerships, and have little meaning in the context of a C-corp )They are called distributions but should be treated as dividends if they still have basis above what they are taking. Correct;he needs to amend all open years, and keep a copy for his records.


“Any other thoughts on how to proceed from here? things to consider? would I have to create W-2s for all those years he paid himself as a draw? would we need to submit 940s for those and pay taxes and penalties?”=======> The IRS is very clear about this. When services are performed, the correct form is a W-2. Any other cash is declared on the 1099-DIV. Dividends come from accumulated earnings of the corp. You can't pay more than the accumulated earnings out. There are two primary ways to withdraw money from his corp. As an EE of the corp, he is entitled to just compensation for any services he renders the corp. As the president of his corp, he is entitled to a salary. So, he may have the corp pay him a salary on W2. This is the first way most entrepreneurs remove money from an incorporated business. The disadvantage to paying himself a wage is that wages are subject to various employment taxes, for example, Social Security and Medicare taxes, in addition to income tax on 1040. While corps don't pay self-employment taxes (you're an EE of the corp and not self-employed), paying yourself a wage lops off about 16% of the wage in employment taxes. For tax purposes, the owner of a C corp is categorized as self-employed. Therefore, in addition to federal and state tax, the owner must also pay a 15.3 percent tax on any salary, as said above, he receives from the corp. A C-corp owner can avoid this tax by not paying himself a salary; the second primary way that a corp passes money to its SH is with dividend payments. Because he is a sh/offficer of his corp,he can receive corporate dividends. So, if the corp earns $1K, it pays taxes on the $1K. Suppose $850 remains after paying corporate income tax. Suppose that this $850 is paid to him as a corporate dividend. Then, he, as an individual taxpayer, must also pay income tax on the dividend received. After paying income tax at his personal marginal tax rate, he maybe have $600 of the original $1K in his pocket after all taxation. So, he effectively paid 40% of his earnings in income tax. And, this assumes relatively low tax brackets at both the individual and corporate level!however, this may result in double taxation from income and dividends. Because of the heavy tax hit, smaller C-corps hesitate to pay dividends. Allowing earnings to accumulate in the company up to the federally allowed limit may be more feasible. You can either amend the 1120 without officer compensation on W2 or amend the 1040s with W2 and I guess both will end up having the tax payer pay payroll taxes, interest, and late payment penalties. Either way, more money will have to go out of the pocket... Either the C Corp or the Officer/owner. Form 940 is based on the initial $7k that ERs pay as wages to each of their EEs;the Corp will have to file Form 940 and as long as it pays FUTA taxes for him, the EE.



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  #3 (permalink)  
Old 01-18-2013, 10:42 PM
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Quote:
Originally Posted by Wnhough View Post
“the person who did them, filed a schedule c, as if he was a sole prop. He has not gotten any notices from the IRS yet but I'm afraid he might owe lots of money in penalties and interest.”===> I guess his tax accountant may have treated his C corp as SMLLC/sole proprietor since he/she didn’t know that your friend incorporated his biz as a C corp. I mean as long as he is a SMLLC owner(not setup to be taxed as a C Corp.), then no W-2 should have been prepared in this case.
He is set up to be taxed as a C-corp.

Quote:
Originally Posted by Wnhough View Post
“He has been paying himself as draws from the business.I am assuming that we need to do the 1120 tax returns for the last 3 years, and the amend the 1040 tax returns for the same years as well.”========> C" corp can't take a draw. It is essentially a dividend if not taken as payroll on W2. (Draws" are terms that apply to partnerships, and have little meaning in the context of a C-corp )They are called distributions but should be treated as dividends if they still have basis above what they are taking. Correct;he needs to amend all open years, and keep a copy for his records.
So let's say in this case the distributions taken by him throughout the year 2012 should have had payroll taxes taken out, correct? Then a W-2 is to be prepared as well as four 941's (for each quarter) and one 940 annual for FUTA.


Quote:
Originally Posted by Wnhough View Post
"Any other thoughts on how to proceed from here? things to consider? would I have to create W-2s for all those years he paid himself as a draw? would we need to submit 940s for those and pay taxes and penalties?”=======> The IRS is very clear about this. When services are performed, the correct form is a W-2. Any other cash is declared on the 1099-DIV. Dividends come from accumulated earnings of the corp. You can't pay more than the accumulated earnings out. There are two primary ways to withdraw money from his corp. As an EE of the corp, he is entitled to just compensation for any services he renders the corp. As the president of his corp, he is entitled to a salary. So, he may have the corp pay him a salary on W2. This is the first way most entrepreneurs remove money from an incorporated business.
I believe this is the way we would do it since he preformed services for the business and therefore earned a salary from it. Say we decide to take for example half of the distributions as dividends and half as salary, what would be the tax implications? for the business and for him?


Quote:
Originally Posted by Wnhough View Post
The disadvantage to paying himself a wage is that wages are subject to various employment taxes, for example, Social Security and Medicare taxes, in addition to income tax on 1040. While corps don't pay self-employment taxes (you're an EE of the corp and not self-employed), paying yourself a wage lops off about 16% of the wage in employment taxes. For tax purposes, the owner of a C corp is categorized as self-employed. Therefore, in addition to federal and state tax, the owner must also pay a 15.3 percent tax on any salary, as said above, he receives from the corp. A C-corp owner can avoid this tax by not paying himself a salary;
Could you elaborate on this? say we decide that he is to pay himself a decent salary from the corp, then we take payroll taxes. What do you mean by "for tax purposes, the owner of a c corp is categorized as self-employed"?

Quote:
Originally Posted by Wnhough View Post
the second primary way that a corp passes money to its SH is with dividend payments. Because he is a sh/offficer of his corp,he can receive corporate dividends. So, if the corp earns $1K, it pays taxes on the $1K. Suppose $850 remains after paying corporate income tax. Suppose that this $850 is paid to him as a corporate dividend. Then, he, as an individual taxpayer, must also pay income tax on the dividend received. After paying income tax at his personal marginal tax rate, he maybe have $600 of the original $1K in his pocket after all taxation. So, he effectively paid 40% of his earnings in income tax. And, this assumes relatively low tax brackets at both the individual and corporate level!however, this may result in double taxation from income and dividends. Because of the heavy tax hit, smaller C-corps hesitate to pay dividends.
Quote:
Originally Posted by Wnhough View Post
Allowing earnings to accumulate in the company up to the federally allowed limit may be more feasible.
How is this done and what are the allowed limits?


Quote:
Originally Posted by Wnhough View Post
You can either amend the 1120 without officer compensation on W2 or amend the 1040s with W2 and I guess both will end up having the tax payer pay payroll taxes, interest, and late payment penalties. Either way, more money will have to go out of the pocket... Either the C Corp or the Officer/owner.
No 1120 forms were submitted ever, so we would submit 3 new 1120 forms for the last 3 years. I guess my question in this case would be, what is the fastest way and cheapest to fix all of this? I realize that there will be penalties and interest but would it be easier to just declared all the money he took in each year as dividend, with the 1120 having no salary for the owner (wouldn't that cause a red flag in the eyes of the IRS?) and amend the 1040 with a 1099-Div?


Thank you for all help btw, you've been great, we are learning a lot.

J



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  #4 (permalink)  
Old 01-19-2013, 12:36 AM
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“He is set up to be taxed as a C-corp.”====>That is exactly what I meant; he didin’t need to file Sch C/Sch SE as a C corp but had to file form 1120 as you can see.


“So let's say in this case the distributions taken by him throughout the year 2012 should have had payroll taxes taken out, correct?”--========>You can say that as long as the C corp pays salary to the officer/sh.however, C corp distribution itself is NOT subejct to payroll taxes;I mean distributions are from retained earnings and the corp has already paid income taxes on those earnings. The top brass of a C corp typically receive occupational benefits similar to other workers, including a salary;however, Corporate officers, though they are EEs, also may accept an employment contract that excludes salary payments if they own a majority of shares, in which case they make money when the business generates revenues. ;corporate officers who temporarily or permanently forgo periodic remuneration aren't uncommon.

“Then a W-2 is to be prepared as well as four 941's (for each quarter) and one 940 annual for FUTA.”It is up to you; you can do that . as said above as long as the officer/sh is paid as an EE of the C corp.

“I believe this is the way we would do it since he preformed services for the business and therefore earned a salary from it. Say we decide to take for example half of the distributions as dividends and half as salary, what would be the tax implications? for the business and for him?”==========>Can you arbitrarily take half of the distributions as dividends and half as salary????as said, distribution is from E&P, I mean retained earnings(for accounting purposes). It does not make sense to pay yourself salary from retained earnings thathas already been taxed. The corporation has already paid income taxes on those earnings. Paying income taxes twice is really the worst thing you could do. In general, C-Corps are taxed separately from their shareholders. Any salary paid to yourself is deductible as a business expense to the C-Corp as you can see. Also, if the C-Corp distributes dividends to the shareholders, the dividends are taxed at a special "qualified dividends" tax rate of 0!~15%.dependign on yur personal marginal taxrate. Dividends from a corporation areUSUALLY taxed twice, once at the corporate level and again at the shareholder level on sh’s return on 1040 I mean. Since the corporation has already paid tax on its earnings, this distribution qualifies as a "qualified dividend" at the lower 15% tax rate. C-Corps are the only business that can split profits between retained earnings and dividends.


The disadvantage to paying himself a wage is that wages are subject to various employment taxes, for example, Social Security and Medicare taxes, in addition to income tax on 1040. While corps don't pay self-employment taxes (you're an EE of the corp and not self-employed), paying yourself a wage lops off about 16% of the wage in employment taxes. For tax purposes, the owner of a C corp is categorized as self-employed. Therefore, in addition to federal and state tax, the owner must also pay a 15.3 percent tax on any salary, as said above, he receives from the corp. A C-corp owner can avoid this tax by not paying himself a salary;

“Could you elaborate on this? say we decide that he is to pay himself a decent salary from the corp, then we take payroll taxes. “====>The Social Security Administration claims that all corporate officers must take a salary for work performed. alsoIt would appear the IRS now would like for a C-corp to pay W2 salary and collect the 15.3% employment tax. Therefore, it is understandable that the IRS may be looking to force officers to take a reasonable salary in a C-corp.
“What do you mean by "for tax purposes, the owner of a c corp is categorized as self-employed"?”============>This doesn’t mean the owner of a C corp is actually self employer or a 1099 income earner;however, it means that just like a self employer , the owner of C corp needs to pay 15.3% of FICA tax since owners/Employers are required to match a certain amount of the Social Security and Medicare taxes they withhold from EE’s paychecks. Ok???? If you run a business/ corp in which you pay EEs, you will need to withhold and match social security taxes.

“Allowing earnings to accumulate in the company up to the federally allowed limit may be more feasible. How is this done and what are the allowed limits?”=======>When r/e are being accumulated over the years, the amount of r/e can get substantial, especially when these are not distributed out in the form of dividends to the shareholders. Accumulated earnings tax is a tax imposed by the IRS on Corps withr/e that is "deemed to be unreasonable and in excess of what is considered ordinary".Corps have clearly an incentive not to distribute the dividends from retained earnings to avoid the dividend income due to double taxation as said previously. The IRS imposes an additional accumulated earnings tax of 15 percent on r/e of a corp that accumulates above $250K. The IRS has established a limit of acceptable retained earning of $150K for certain "personal service corporations" (i.e., corporations in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting, where the owners provide the services). As discussed above, this tax is only applicable to 'C' Corporations.


You can either amend the 1120 without officer compensation on W2 or amend the 1040s with W2 and I guess both will end up having the tax payer pay payroll taxes, interest, and late payment penalties. Either way, more money will have to go out of the pocket... Either the C Corp or the Officer/owner.

“No 1120 forms were submitted ever, so we would submit 3 new 1120 forms for the last 3 years. “======>
Correct and you need to amedn your past three year 1040s based on Sch C/Sch SE
“I guess my question in this case would be, what is the fastest way and cheapest to fix all of this? I realize that there will be penalties and interest but would it be easier to just declared all the money he took in each year as dividend, with the 1120 having no salary for the owner (wouldn't that cause a red flag in the eyes of the IRS?) and amend the 1040 with a 1099-Div”======>I guess you need to contact the IRS/ your state Dept of Rev ASAP. You should file all tax returns that are due, regardless of whether or not full payment can be made with the return. Depending on your circumstances, youfiling late may qualify for a payment plan. All payment plans require continued compliance with all filing and payment responsibilities after the plan is approved. However, full payment of taxes saves you money.



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