Discussion:Single Member LLC owner draws/payroll

For tax purposes, how do I handle the owner draws against paid in capital? Can an owner take a draw against paid in capital and not have to pay taxes on it, thereby reducing their equity in the business and deferring the tax until the liquidation or sale of the business?

How do I handle her W-2? Do I just post the income to page 1 of the 1040 and the withheld taxes to page 2 of the 1040, or do I need to put the income on the Schedule C and treat the withholding as estimated tax payments? How would I address the Schedule SE and the withheld social security and medicare if I disregard the W-2 and try to put everything on the Schedule C and Schedule SE.

Thanks

Please see my response in the thread you originally posted to.

Proper way out of this mess is to correct the filings of everything done incorrectly.

The single member LLC/schedule C net profit is taxable regardless of the amount of capital put into the business or withdrawn. Draws are not deductible (nor are capital contributions income)- they are totally disregarded.

I think a good many tax preparers would consider deducting the owner's wages on schedule C along with all of the other wages, and paying taxes on the resulting net profit on the owner's form 1040. The W-2 income and withholdings would be shown on the 1040 in the normal fashion, as if they came from an outside employer. Normal Schedule SE calculations would reduce the income subject to SE taxes by the wages shown on the W-2.

This might be sticking your neck out but I've seen it done that way in the past, when a new business owner makes the same mistake your hairdresser did in their first year in business.

Treating the taxes withheld on the W-2 as estimated payments won't work because they won't match up in the IRS' system of tracking estimated payments, which is separate from their tracking of taxes withheld on forms W-2.

If you disregard the W-2, the four quarterly form 941 payroll returns would have to be amended and she would receive a refund of all of the taxes paid for herself. I know of no mechanism for applying form 941 overpayments to individual forms 1040. Also she would get federal and state unemployment taxes paid on her wages back. A corrected form W-2 showing $0 wages would need to be issued as well. She would owe a bunch of taxes with her 1040 plus some underestimation penalties.

For 2007, you should definitely fix the situation effective January 1. One option would be to take her off payroll and set her up to make quarterly estimated payments. A second option is to submit a check-the-box election, electing to be taxed as a corporation. It's likely that you would want to make the S election if you take this route. I haven't done this lately but I believe you still have time for 2007 elections. Choosing to be taxed as an S corporation just so the owner can be paid wages with taxes withheld may not be a bad business decision, especially since there are already other employees causing payroll forms to be required.

Good luck!

Regarding the draw, how does this get treated. For instance, can she take the first $250,000 out of the business tax free and just reduce pain in capital? I know that pain in capital and owner draws do not get taken into account on the 1040, but they are in Quickbooks and something has to be done with them.

I apologize if my comment was viewed as rude. I sincerely did not mean it to be insulting. I also, at that time, had not read your profile. Please accept my apology.

I did, however, give you the correct answer as to how to handle the issues. Unfortunately, the mess, to be correctly handled, will be quite a lot of work. Have all the final payroll returns been filed?Ideally, you would need to correct what has been reported. She also has paid fed unemployment tax and probably a state unemployment tax she should not have.

As stated above, the draws are a non-issue as they do not reduce the net income earned on the Sched C.

Once again, I'm sorry for my brusqueness.

Good luck with this.

Msmith,

No apology needed. I am on a couple of other chatboards that are hobby related (e.g., hunting, fishing, shooting, and cycling) and I have been a mod on one for something like 6 years, so I know that some things don't get conveyed properly over the internet. I probably should have waited to respond to your other post until after walking the dog, eating something, and getting rid of my headache.

Thank-you!

My wife would love you. She is a gator and I am having to live through their championships at the moment. It sucks being a terps fan. Before I met her, the Terps won the men's NCAA tournament. Since then, nothing. Well, I guess they won the women's NCAA tournament last season, but does that even count?

I am also curious to know why a sole proprietor or single member LLC owner cannot pay themselves a salary via payroll. My biggest problem with some of my clients is that they do not have money to pay their estimated taxes when they are due. It is much easier for them never to see the money. The lady I mentioned above used to make $60,000 a year working for somebody else and she would say she is poor back then. This was before she was a client of mine, and merely a family friend. Now, she doubled her income and she still says she is poor. The reason is that she spends everything she makes. She had a Lexus RX330 that was 2 years old and she had to upgrade to a new one because the other one was dirty, she wanted a new color, and she wanted navigation. She told me that it didn't cost her anything extra because her payment is still the same, but for an additional 2 years, and all she had to do was put $12,000 down on it. I could go on, but it wouldn't be worth it. I am actually scared to tell her to just take draws and we will pay estimateed taxes 4 times a year. Something tells me that come tax return time she would be crying.

I have had 1099 clients come to me with $90,000 in income and absolutely no estimated tax payments made during the year and no savings whatsoever. One client did it two years in a row, and the second year she was talking to me from Cancun on vacation as she owed the taxing authorities $25,000 from the previous year and was looking at another $25,000 for the current year, not to mention penalties and interest. After I filed her first tax return, which was in September because she filed an extension without paying any tax with the extension request, I tried to get her to cut back on spending and make estimated payments for the current tax year and monthly payments for the previous year, but that never happened. After I prepared her second tax return, her check for my invoice bounced. She didn't even own a car or a house. I didn't send her an organizer for the third tax year.

For those who cannot budget, incorporate and pay yourself weekly and deposit your taxes on Form 8109-B weekly.

You cited Pub 334. Here it is... For Schedule C expenses it says "You cannot deduct your own salary or any personal withdrawals you make from the business. As a sole proprietor you are not an employee of the business."

I have a question - please don't eat me alive.

Remember the SMLLC I was talking about on the other thread Discussion:Employer gives employee stock?

Well, this guy came to me a couple of years ago and had been set up on payroll. I do not handle his books or payroll. I just do his taxes - Sch C disregarded entity SMLLC.

Should I be advising him otherwise on the payroll situation? I mean, after all, it is costing him more money to be on payroll because of unemployment tax he pays for himself. Or should I just let sleeping dogs lie?

Again, please be gentle...:)

What you all apparently read: Can someone spend their leisure time researching this question for me? I'd prefer a detailed answer so that I won't have spend any of my own time.

In reading through a lot of these discussions it seemed to me that many of you could rattle off code sections and reg #'s like you can your own phone numbers. All I was looking for was off the top of someone's head to say, "take a look at...."

Instead I get lectured from the person voted "Top Contributor to the Board". So yeah, I got a little ticked. And I had already spent time trying to find the answer myself but failed. So I asked what I beleive was my first question here.

But don't worry, for now on I'll lurk in the shadows (like a gator).

As for the other thread running here, where's my white flag?

Deb - Yes, of course. It will save him some money anyway. I am not sure why he was set up like this in the first place, but going forward for 2007, I will advise him to stop the payroll on himself.

It's all good - I appreicate your reply!