S-Corp late election - how to report payroll tax

[TaxesTech]

My client decided to elect to be an S-Corp by filing Form 2553 pursuant to Rev Proc. 2013-30 together with the first Form 1120S.  He is a 100% shareholder.  As the election was made after the Form 941 and Form 940 filing deadline, in this case, how should I report payroll tax for him?

[qbteachmt]

"in this case, how should I report payroll tax for him? "

Late. It's all late. You need to "do payroll" and there will be taxes and penalties, too.

[TaxesTech]

Why can't I file a Schedule C for the business owner as if the S-Corp 1099'ed him and report both EE and ER portion or payroll taxes on schedule SE?  Technically I should force the Schedule C QBI deduction to zero but it just does not make sense that Rev Proc 2013-30 allows retrospective late election, and there is no corresponding payroll tax filing process in place to facilitate this.  

In nature the S-Corp did pay the 100% owner as a 1099 contractor, and I think the QBI deduction is appropriate too.  

[qbteachmt]

"Why can't I file a Schedule C for the business owner as if the S-Corp 1099'ed him and report both EE and ER portion or payroll taxes on schedule SE?"

Because this is not the person being a subcontractor to their own entity by running a different entity. In  addition, in the simplest terms, think of your proposal as Worker Misclassification, setting aside the issue of trying to have your own entity treat you as independent.

And the other issue is to understand that the IRS will look at any funds taken from the S Corp (you would call it Draw from the Sched C business), which is Distribution in the S Corp and if not taking a reasonable wage through payroll, and they recharacterize it as Payroll, because an S Corp is required to have payroll for the people it hired to do its business. Then, the IRS will declare you attempted to avoid Payroll taxes, which is punishable as tax avoidance is illegal. So, did you want payroll recharacterization, or just confess to it up front but be late about it?

"In nature the S-Corp did pay the 100% owner as a 1099 contractor, and I think the QBI deduction is appropriate too."

Is there something else you overlooked telling us? It's a subsidiary, the person was paid as an employee through the other corporation, they didn't even do business in 2020 and payroll is timely now for Jan 2021, perhaps there were no operations and only startup? Are you setting a Fiscal Year?

You should review what the IRS requires, including as example:

• The entity and all shareholders reported their income consistent with an S corporation election in effect for the year the election should have been made and all subsequent years; and
• Less than 3 years and 75 days have passed since the effective date of the election (See the Exception to the 3 Years and 75 Day Rule section below).

So far, nothing here is "special."

[TaxesTech]

It sounds like I invite you to my house for dinner, triggered my anti-robbery security system to report you to the police.  I watch you to be arrested by the police and do nothing.  

I appreciate your insights from the compliance perspective, but I don't understand why it is a payroll tax evasion as schedule C report both employer and employee payroll tax liability.  

[TaxesTech]

Also, do you have any court case to share on such similar scenario?  The Rev Proc 2013-30 is nothing new and I'm sure many people have been facing such dilemma in the past.  

I really appreciate your taking your time answering my question, and I did learn a lot from you.  Thank you.  

[qbteachmt]

This is not how I stated it: "but I don't understand why it is a payroll tax evasion as schedule C report both employer and employee payroll tax liability."

This is the copied text: "And the other issue is to understand that the IRS will look at any funds taken from the S Corp (you would call it Draw from the Sched C business), which is Distribution in the S Corp and if not taking a reasonable wage through payroll, and they recharacterize it as Payroll, because an S Corp is required to have payroll for the people it hired to do its business."

The "why" is because the IRS states it as such.

Just search the web for:

Reasonable Compensation S Corp

[TaxesTech]

Thank you for clarifying.  I am rule follower but I think principal is the more important to understand to make professional judgement.  As the US tax code is so complex, any rule has exception, exception of exceptions, and those will be again applied differently depends on how the tax court rule over certain cases.  I have studied very carefully about the S-Corp officer comp's reasonableness, but as my original question is based on a special provision of Rev 2013-30 and the timing issue is caused by law, but not by the taxpayer's choice of not to run officer comp through payroll.  I believe there should be court case govern this real life situation.  The QBI however, could be a loop hole there as it is a new law from December 2017.  I doubt any court case would have a chance to appear over that.  All in all, I think the rule you have pointed out did not take Rev Proc 2013-30 into consideration, and if you have any case law taking it to consideration, that would be very helpful.  

[IRonMaN]

Why was the election done, if he really didn't want to treat the business as an 1120S?  Folks that don't want to take out payroll should go the LLC route and stay a schedule C.  Corporations aren't a proper fit for everyone.

[qbteachmt]

I cannot help on the issue of principal or professional judgement. What I did is lead you to the issues. I can't do your legal research for you; this is a peer community and we have our own clients. I pointed out that the IRS has requirements for this. You asked about Payroll and yes, there is time to do payroll, and it is late, but nothing prevents it from being submitted.

Good luck.

[TaxesTech]

I think that is a good question why the election is done.  Another way to ask the same question is why there is a Rev Proc. 2013-30.  I came from Big 4 subsequent technical accounting on derivatives.  But due to COVID I am one of the small business player now.  Small businesses are extremely underserved and I am passionate to start new initiatives to bring service quality to small businesses as well. 

Originally it is a question on how to report on a very common scenario that is commonly not done right.  I am just trying to clean this process up.  I did not expect it become an academic debate and that is why I love tax.  So there is basically no answer without digging in case law.  

I did not mean to make you do research - I just think you are very knowledgeable and maybe you have a case number on mind.  If not, that is totally fine.  I am accumulating all these little things and this would be one of the most precious cases in my notes.  

Thank you and I hope you have a great day.  

[TaxesTech]

yeah it is happen to be an LLC also discovering cool business trend and his revenue was $300K last year but but this year his making more than a million gross receipts.  Never any CPAs offered real service to him.  

[qbteachmt]

I can provide a bit more input. On the issue of Employee Wages or Independent:

You know the Sched C filer is not allowed to take their "pay" as expense. When you are your company or business, you are not an expense to yourself.

The Supreme Court has ruled that Corporations are People, too. A shareholder that does not work for the corporation would not be paid for work. But a corporation isn't able to perform any business, and it needs to "hire humans" to do that work. These Humans are employees. That's why the shareholder-employee is not their own contractor. And their wages are payroll expense.

[rbynaker]

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@TaxesTech wrote:

I think that is a good question why the election is done.  Another way to ask the same question is why there is a Rev Proc. 2013-30.

I'll chime in, mostly because I appreciate your being polite.  We need more of that here.

The late election procedures exist for the umpteen cases where the lawyer thought that the accountant was going to file the 2553 and the accountant thought the lawyer was going to do it.  Meanwhile the client put themselves on payroll and rather than try to unwind a bunch of payroll that has no business being on Schedule C the IRS allows the late election.  They don't want to have to process all of those amended payroll returns either.

If you read the RP though you'll find that it requires that "The Requesting Entity intended to be classified as an S corporation".  IMO if you never started payroll then it's hard to argue that an S election is anything more than an afterthought.

Rick

[qbteachmt]

I pointed out the "shoulda" part, as well. I cannot determine if the question for 2020 now is:

Should I foll through with the S Corp election?

Or,

Should I not follow through with the S Corp election?

Because none of the answers lead to 1099-NEC scenario.

[TaxesTech]

This is very interesting, thank you.  

[TaxesTech]

I think the most reasonable solution is for IRS to set up an exception on the late payroll process for tax payers who adopt Rev 2013-30, and waive the late filing penalty and incremental burden on the taxpayers.  Because many taxpayers are unaware of the S-Corp election could benefit them, like my client, who is not a start-up business, and making more than 100% business growth every year.  If you are unaware, you won't have the intent to make the election timely.  You could have made the election timely if you were aware that was an option.  Is there a way to propose the IRA to provide some relief on this, so people do not get penalized by trying to do the right thing? 

The IRS do have Rev Proc 2016-47 to waive 60 day roll-over requirement when the taxpayer is unaware of the receiving account was not a qualified plan.  

[IRonMaN]

No.  If someone is making an election for them, that person should make sure that the client knows what the requirements are.  As I mentioned before, too many folks elect to be treated as a corporation when they really should stick with being a schedule C.  Go the LLC route if they want some legal protection, but stay away from Sub S treatment.

[qbteachmt · Accepted solution]

"to set up an exception on the late payroll process"

Let's understand the no one here provided the recommendation to apply for this as a Late election; we don't know who gave that recommendation or why.

I did post this, copied from the IRS: "The entity and all shareholders reported their income consistent with an S corporation election in effect for the year the election should have been made and all subsequent years"

Which is why @rbynaker contributed an example of why late election might be appropriate.

"and waive the late filing penalty and incremental burden on the taxpayers."

It's a one-time thing, to do an annual payroll. And I like to point out, doing it timely or doing it later is the same amount of work. There is no Added burden here.

"Because many taxpayers are unaware of the S-Corp election could benefit them"

There's very little additional benefit to this election for single-member LLC/Sole Proprietorship with no employees.

"Is there a way to propose the IRA to provide some relief on this, so people do not get penalized by trying to do the right thing?"

Well, "I didn't know" is not really an excusable exception, if none of the conditions are being met.

It seems you are insisting this will be S Corp for 2020 activities.

There is always the possibility you can make precedence or get a private ruling:

https://www.irs.gov/businesses/small-businesses-self-employed/late-election-relief