Need help for filing correction for 2019

[TaxStyle]

Hi everyone, 

Hope you guys had a great Thanksgiving. I need some helps and guidance and hope someone can help me out.

Here is the story. My client set up a company because people advice her to, but she wasn't clear about whether it is an S corp or C corp when I talked to her. So later I found out it is an C corp when i prepared her 2020 return, and she is the sole owner and the only member of the C corp. However, her 2019 return (initial return) was filed using S corp form 1120-S.  Now she received a letter from IRS saying that her 2019 return cannot be processed, because it doesn't match.

Now i need to refile a 2019 return for her using the correct form. so i have following questions need help with..

1. so it is a basically new filing, not amending the 1120-S from 2019, since the form and entity type will be totally different. Will it count as a late filing? the IRS agent said I can attached the letter, and it should help to clarify.

2. since 2019 was filing under S-Corp, the income was flow through to individual income 1040. How does this going to get affected? Do I file the 1120 first and wait a little then file an amending 1040? or they can happen simultaneously? 

3. my client will owe tax from the correct C corp 1120 filing, but will get refund from the amending 1040 since the income from the company is not flowing to individual anymore. Does she need to pay the C Corp tax up front and wait for the refund from individual later? or there is a way to just ask IRS to apply the refund to C Corp tax, and she doesn't need to do anything from her end?

4.How does the state return(California) gonna get  affected? since there is no letter/notice received from State. Do I wait for everything from federal level is cleared then work on state returns or I can do it at the same time? 

5. I am assuming attached a letter to explain to the state authority about the situation is needed instead just sending in new/amending state returns?

PS: i called IRS, the answer i got is just filing the 1120 for C corp first. And the person i talked to had no knowledge about how the individual and state returns will get affected. So I come here to ask, and want to see a full picture and flow first instead just filing first and take one step at a time.  

Thank you very much for your time to read through this, any help and advice is much appreciated.

[IRonMaN]

File the 1120 and include the letter and a little explanation (just by chance the IRS reads it) as to why it is filed late.  Amend the federal and state returns 1040 removing any amounts flowing from the 1120S K-1.  You also might want to amend the 1120S returns adjusting showing zeroes -------- just for a little icing on the cake.

[rbynaker]

I'm sure most of the income from the Corp activity was already passed through on her W-2, right?  🙂

In my old(er) age, I just decline these "janitorial services" opportunities.  But I would start with the bookkeeping.  If she didn't know what kind of entity she was, she likely also didn't know that she needed to be doing payroll.  My guess is you'll find the can of worms is that she just took money willy-nilly out of the Corp.  With a C Corp, are those wages or dividends?  You can't fix the 1040 until you know the amounts and flavors of income from the Corp.  Even if things were done correctly assuming it was an S Corp, (reasonable salary for time spent plus owner distributions as appropriate), any distributions would become taxable dividends from a C Corp (i.e. subject to taxation at both the corporate level and the individual level) instead of tax-free basis reductions from an S Corp.

If you're lucky enough, you'll find that she set up a Corp but then proceeded to just run all of the money through her personal bank account (a.k.a. Sch C).

In any case, get the facts and then ask your tax questions.  At this point, don't assume anybody knew what they were doing or are competent enough to tell you what actually happened.  Follow the money and find out on your own what actually happened.  Accountants politely call this "trust but verify".  My translation of the phrase has always been "you have no idea what you're talking about, let me see your business records."

Rick

[TaxGuyBill]

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@TaxStyle wrote:

My client set up a company because people advice her to, but she wasn't clear about whether it is an S corp or C corp when I talked to her.

So later I found out it is an C corp when i prepared her 2020 return, and she is the sole owner and the only member of the C corp. However, her 2019 return (initial return) was filed using S corp form 1120-S. 

Take a step back.

What type of taxation do YOU think is best for her situation?  S-corporation?  C-corporation?  Sole Proprietor?  Something else?

You said the client set up a "company".  What does that mean?  Is it a corporation?  Or is it something else, such as an LLC?  It it was an LLC (or something similar), was an election filed with the IRS to tax it as a C-corporation?

Has 2020 already been filed as a C-corporation?  If not, and *IF* S-corporation is optimal, it seems like filing a late S-election may be applicable.   But I think 2020 has already been filed as a "C", it would mess up the ability to file the late S-election.

[qbteachmt]

Just because someone sets up a corporation doesn't by definition make it "doing the business" as intended. She could have been operating as a Sched C, set up a C Corp, but never took any action that would change the business activities to "done under the corporation" at all. In other words, did she keep operating as she had been, or did she take any action that shows this C Corp was in fact in operation?

The 1120S might still be the wrong thing to do, but there is no assurance there is a C Corp doing anything, unless she did take the required actions and you can prove that happened.

[joshuabarksatlcs · Accepted solution]

@TaxStyle You stated the facts below.  I'm NOT going to go off on a tangent to discuss things like corporate formalities, commingling corporate funds, whether the biz was run like a corporation, what "setting up a company" could also mean, or speculations like whether the owner pocketed the funds or she filed a schedule C or whether she suffers from chronic constipation....  Here, I generally take the facts literally and address the questions as asked based on the given facts.  If other tax angles are there to be considered along the line of my discussion, I will mention them.

Your questions were very clear to me.  So here it goes. 

Stated facts:  So later YOU found out it is an C corp when YOU prepared her 2020 return, and she is the sole owner and the only member of the C corp. However, her 2019 return (initial return) was filed using S corp form 1120-S.  Now she received a letter from IRS saying that her 2019 return cannot be processed, because it doesn't match.

Basically a tax can of worms, or is it a can of tax worms.  I have NEVER had worms like these.  Below, I'll tell you how I would approach it - NOT answers.  Just suggested directions. 

Actually, part of what I suggest below is an expansion of what @TaxGuyBill said.  He nailed it on the head.

Take a step back.

What type of taxation do YOU think is best for her situation?  S-corporation?  C-corporation?  Sole Proprietor?  Something else?

As your client's advisor, you may want to help her to decide the best for her business.  That said, assuming the incorporation was NOT voided, even if it was decided an entity OTHER THAN  a corp. was the best, practically, you still have to deal with the corp filing UNTIL it's dissolved.

SO, for years 2019, 2020 and 2021 (and soon 2022 unless the corporation is dissolved before 12/31/2022), you still have to deal with either 1120 or 1120S filings.

*** Remember when you read on.  I'm just suggesting directions for your research.  I don't know the feasibility  ***

2.  Plan A - If client decided to go with S corporation.

2.1  Look into a late F2553 filing.  See Rev Proc 2017-34.  the corporation is still within the 3 year and 75 days period [per Section 4.02(2)] .  The way to do it (but see 2.2 below) would be to file (refile the original) F1120S with Form 2553, both bear the "FILED PURSUANT TO REV PROC...." marking - that is, on both F1120S and F2553.  

2.2  Amend 2020 F1120 to all zero.  File it as a final return.

2.3.  File 2020 F1120S with F2553.  Include the explanation as part of F2553.

2.4.  NO need to amend 2019 1040/540.  

2.5.  Late filing penalties for 2019 and 2020 F1120S.  (See 4 below)

2.6.  In particular, you need to research: "Would the filing of 2020 F1120 preclude a late F2553 filing??"  You're totally on your own on this.  I have ZERO clue.  If YES for the question, Scratch Plan A.  

2.7.  @TaxGuyBill  said: But I think 2020 has already been filed as a "C", it would mess up the ability to file the late S-election.  Source?

3.  Plan B - If client decided to go with C corporation OR if 2.6 above is YES.

3.1.  File F1120 for 2019, which would be hit with Late filing penalties.  (You stated net income for 2019). 

3.2.  The F1120S was rejected.  NO action needed for the rejected F1120S.

3.3.  Amend  1040/540 to back out the K-1 income.

3.4.  NO change for 2020 filing.  (F1120 already filed)

4.   Late penalties

4.1. See 3.1 and 2.5 above for the filings subject to penalties.

4.2.  Either pay the penalties OR write to request for penalty waiver.  

4.3.  For penalty waiver, research IRM 20.1 - Particularly 20.1.1.3.6 and 20.1.1.3.3.2.1 to see if the First offense waiver is still available and applicable.  

https://www.irs.gov/irm/part20/irm_20-001-001r#idm1397614523489123

5.  Your questions.  

5.1  I think the above would either answer your Q1 and Q2 or give you enough headache about them

5.2   Your Q3:  is there is a way to just ask IRS to apply the refund to C Corp tax, and she doesn't need to do anything from her end?  NOPE.  These days you would have a hard time moving the credit for the tax payments made for one year to another for the same entity/tax form.  NO WAY to apply refund for 1040 to 1120...

5.3.  Your Q4 4.How does the state return(California) gonna get  affected?  since there is no letter/notice received from State. Do I wait for everything from federal level is cleared then work on state returns or I can do it at the same time? 

CA recognizes Federal S election.  NO separation action needed.  It makes sense to do it at the same time.

5.4  Your Q5   I am assuming attached a letter to explain to the state authority about the situation is needed instead just sending in new/amending state returns?

Who is there to read your letter?  Tax filing matters are basically "Form driven".  If there is NO form, how can FTB take action?  I used to work for the state (NOT FTB).  For received letters that we didnt know what to do, we just put in another guy's in box.  As such, your fine letter will just go from in boxes to in boxes, so to speak.

Hope this helps.

(Remember, I'm just suggesting the directions or giving you my take.  My points are NOT the final answers.)

[TaxStyle]

so do you mean i should amending 1120S to all zeros while also filing 1120 for the correct return?

Thanks

[TaxStyle]

Thank you for all the details

there is no W2 for her, but yes, i should check if she make any withdraw or distribution.

Thank you

[TaxStyle]

the "company" just referring to my client wasn't clear what type is it.

but now i am sure it is a C corp. and 2020 is filed as a C corp also. so if any election to make to S corp will be in the future years.

[TaxStyle]

this is awesome, thank you for all the suggestions

I take a close look on each one. 

much much appreciation

[joshuabarksatlcs]

@TaxStyle  asked: so do you mean i should amending 1120S to all zeros while also filing 1120 for the correct return?  

I take it that the question was about 2019.

Plan A and Plan B are mutually exclusive.

Plan B may also be:

* C corp for 2019, 2020 and 2021; and

*  File F2553 to elect S Corp beginning 2022.  Then in the future your client will have an S corp with E&P. 

Regardless, for Plan B, I wrote: 3.2.  The F1120S was rejected.  NO action needed for the rejected F1120S.  Here are more details:

3.2.  The 2019 F1120S was rejected.  NO action needed for the rejected F1120S.  There is NO F1120S to amend.  Because the IRS could NOT match 2019 F1120S to an S election, filing additional 2019 F1120S would be a waste of everyone's time.  However, this could be messy for CA because CA MAY HAVE accepted the 2019 FTB F100S (with the assumption that the corp had been accepted as S corp by IRS).  A question would then be: "Has IRS informed FTB about the rejection of the 2019 F1120S???"  Even if so, FTB may be sitting on it.  Did your client receive any notice from FTB??? If Client chose Plan B (with OR without electing S corp for future years), I suggest to contact FTB to see if 2019 FTB F100S should  be amended.  Again, Under Plan B, Client will have to amend 2019 F1040 and F540.

Also, Plan A missed a step: Under Plan A, Client's 2020 F1040  and F540 need to be amended.

[TaxGuyBill]

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@joshuabarksatlcs wrote:

See Rev Proc 2017-34. 

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I think you meant Rev Proc 2013-30, right?

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@joshuabarksatlcs wrote:

2.7.  @TaxGuyBill  said: But I think 2020 has already been filed as a "C", it would mess up the ability to file the late S-election.  Source?

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Rev Proc 2013-30.   🙂   And the shareholder's signatures on Form 2553.

Section 5 covers it.  Here is an excerpt:

(5)(i) The Requesting Entity timely filed all required federal tax returns and information returns consistent with its requested classification as an S corporation for all of the years the entity intended to be an S corporation and no inconsistent tax or information returns have been filed by or with respect to the entity during any of the taxable years,

[joshuabarksatlcs]

@TaxGuyBill you're absolutely correct.  Mea Culpa.

I was in a discussion on Estate tax return. My notes for this forum included that Rev. Proc.  

For a Late S corp election (F2553), the correct cite is Rev. Proc. 2013-30.