Discussion:C Corp officer compensation

Husband & wife are sole shareholders and have filed their own 1120 for the past 4 years. They always show officer compensation but have never issued W-2's or 1099 div nor reported any of this on their 1040. They want to take the wait and see approach and not amend the past returns but will change their ways in the future. For this year I have an 1120 with about 34K in officer compensation & I'm asking for some advice on what I should do with this on their 1040.

Needless to say, you should set them up on payroll taxes for 2007. I would also give them a letter recommending they amend all open years, and keep a copy for your records.

For this year, you should really have the CCORP issue W2s and pay for their mistakes =)

How do you report Officer Compensation on Schedule C? The owners can be contractors?

However, by reporting it on Schedule C they will at least pay the taxes they owe. That is because the $34K will be picked up as income and they will pay incomee tax on it (in past years they took a deduction on the 1120 but never reported it on their 1040...a big understatment of income). The $34K will also go to Schedule SE, so they will also pay SE tax on it. That will make up for the fact they failed to pay Fica taxes on the $34K.

The net result is that, even if the return is audited by the IRS and the Schedule C switched to salary, there would be almost no change in tax. Although its all classified wrong by using Schedule C, they will have paid almost exactly what they would owe if they classified it as salaries.

To me, the key to this client is the fact that they are going to get straight for 2007. Based on the time frames involved (considering no quarterly or annual PR tax returns were done for 2006)the Schedule C approach is probably the most expeditious way to complete the return and still not have an underpayment. Of course, if they still wanted to underreport their income I would drop them.

Add in the possibility that they have years of taking deductions on 1120 and not showing the income on 1040, and yeah, I'll pass on jumping into bed with them.

(@OP: If you take the Sched C approach note that they will have first year filings in Port/Mutl Co if they have exposure there.)

Anyway, are these people aware that have signed criminally false 1040s? The slam-dunk evidence is their preparation of the 1120s, and statements made to the orig poster as cooperating witness. Beyond that, nuthin' to worry about.

In light of this, I would insist 941's be filed or amended if filed. Removing comp from 1120 won't work, especially if treatment as distributions is beneficial. T/p's are bound by their transactions. For starters, what's it say for MEMO on the checks and/or in the checkbook? Plus, as new preparer, if we fix it other than the way the Code says, and saves money, we're aiding/abetting! The client may end up the cooperating witness. :-)

If they didn't report the income on their 1040's for prior years, then it would of course be incorrect for corp to book the amounts as expense in those years. It should have been booked as an a/r shareholder and interest should have been accrued. Retained earnings is incorrect. Hmmm. Can you ever sign an 1120 return of theirs in the future if they don't correct the situation? (the answer is no, because you know retained earnings is incorrect)

I would insist on amending all open years of their 1040's to report the income as it should have been, and make them pay the related tax. In addition, I would make an adjustment to income on the corporation for any years that are closed on their 1040 and accrue the interest from the days the funds were taken out of the corp with the offsetting debit to a/r shareholder and disclose it on the 1120 as 'an erroneous mistake' -if it indeed was a mistake. This would make ending retained earnings correct. Have them sign the 1040's and then you mail them (so they aren't just stringing you along to apease you). Charge a big retainer up front to cover all of the above work.

If they balk, walk. You don't need the money that bad.

Sched c is not right.

I have a similar situation. I was just hired by a client to do his C corp for 2006. He ended up with a profit of 800,000 but took the 800,000 out as a sharelholder loan. He did the same thing in the prior year and paid a hugh tax thru the c corp in 2005 and nothing on his 1040 since it was a loan. And now for 2007, he elected S corp status. Which option do I choose for doing the 2006 C corp tax return? Do I leave the 800,000 as a shareholder loan? Do I reclassify this loan as you discussed above to officers salaries and have him report this on Sch C? Do I reclassify as officers salaries and redo his W-2 form and show the full 800,000? Do I leave the 800,000 as a loan and now that his is an S corp, reclassify as distributions of prior c corp earnings? Client is open to doing whatever I think is the best way to save taxes but stay good with the IRS.

Debt forgiveness would be ordinary income, not dividend taxed at 15%. By repaying it, he could take the money out in future years as dividends from a former C Corp at 15%.

1) to reclassify the 800,000 shareholder loan, which was mostly taken out of 2006 earnings, as either a qualifying dividend to shareholder taxed at 15% on Form 1040 and no deduction on C corp

2) to reclassify it as salary-amend the payroll returns. If I do that then of course the 800,000 would be deductible by the C corp and income on the 1040 but then there are payroll tax penalties from Dec 2006 to Oct 2007.

3)Leave as loan and the reclassify to salary in 2007

Any words or wisdom from you guru's?