Form 1120 and how to tax Owners Draws

[SharonAnn]

Hello All,

I need help please...... I have a new Client that is a 2 person C Corp  1120  with subcontractors that will all get 1099-Misc.   

 They  2 owners did not start payroll until September.  I know I can deduct the W2 Salary as a business expense, but what about the Draws they took the rest of the year. 

I am seeing that cannot be a tax deduction unless they are on Payroll?       Thank you in advance,

Sharon

[IRonMaN]

Corporations don't have draws.  If they took "draws" before they started payroll, they were actually taking payroll.  You need to go back and amend and/or file payroll tax returns to correct for the snafu.

[abctax55 · Accepted solution]

Just a few problems with your understanding C-Corps.

1) They don't have "owners"; they have shareholders.

2) The "employees/owners" ie, those that provide services get wages (W-2).

3) Money paid out to these "owners" (your description) is either a loan, or a dividend.  So a Form 1099-Div should be filed.  Dividends are NOT deductible at the corporate level, but are taxable to the recipient.  Thus the reason that closely held corps are usually not C-Corps.

Report back if you really meant this is an S-Corp as the rules are a bit different

[marni]

Payroll or an employee loan.  The loan needs to be documented, interest at AFR.  Dividend treatment - thats an option as well....  

Seems like they didn't know why they chose the entity structure they have and how it works.  

[SharonAnn]

Hello and thank you for responding,

Ok yes, correct  they are shareholders, not owners.      It s not an S Corp 

Maybe I don't understand  as much as I thought.    I am new to from 1120 

However, They had someone else do thier  2018 taxes and they did not have payroll.  They just withdrew money all year and wrote themselves checks.     Last year and that Tax Preparer  deducted all of the cash withdrawals and checks  they made on line 12  Officer Compensation of the 1120.

This tax year  2019 , they started payroll in Sept, but they still withdrew 100K in cash and checks and I want to be sure I do it correct.   

Would the 1099-Div come from QuickBooks?  I did thier 2019 Bookkeeping 

Thank you again

[qbteachmt]

Do they work for the corporation? Perhaps they did no work for the corporation until Sept 2019?

Or, do you simply have three errors:

1. "They had someone else do thier 2018 taxes and they did not have payroll."

2. "They just withdrew money all year and wrote themselves checks."

3. "Last year and that Tax Preparer deducted all of the cash withdrawals and checks they made on line 12 Officer Compensation of the 1120."

Because you might want to address 2018, too...

[IRonMaN]

I'll stick with my original answer that they had payroll for the full year.  I'm also going to go with they had payroll in 2018.  Just because someone else did the return in 2018 and prepared it that way doesn't make it correct.  Based on this discussion, I'm also curious as to whether the contractors that were paid were actual contractors or corporate employees.

[SharonAnn]

Yes they worked  for the corporation in both 2018 and 2019  but they did not know they had to be paid on payroll.  They are painters,  2 of them and they hire subcontractors as they need them.

Yes, in 2018 they had someone else do their taxes and they were not setup on payroll at all in 2018 and I do want to address that but I am here making sure. 

[SharonAnn]

Hi,

They did not have payroll at all in 2018 and only started Payroll in Sept 2019.

They made cash withdrawals and wrote themselves checks both years even after they went on payroll.

[IRonMaN]

But that is all payroll.  Some folks should sit down with a professional before they start a business to make sure they choose an entity type fits their needs.  These guys should not be in a corporation.  

[SharonAnn]

Ok  yes , I  totally agree that they should not be a Corporation.  

I also  agree that the withdrawals/checks  were pay.   But I am seeing that they cannot deduct this type of pay as an expense on form 1120 line 12.      I believe they can only deduct W2 wages as a busienss expense  on line 12  for form 1120 and not the cash withdrawals.   

[abctax55]

4th Quarter returns, and W-2's (for payroll) aren't due until 1/31/2020.  There's still time to make things right, but the deposits will be late and there will be penalties.  Perhaps that would *teach* them to 1) consult with you earlier 2) do things correctly.

I don't think QB can produce anything except F 1099-Misc

"Underpaying" salary in a C-Corp doesn't have the same downside as in an S-Corp..... but those dividends create the dreaded *double taxation* component that exists with C-Corps.

What do the corporate minutes say about salary, loans, dividends, etc  (sorry, I couldn't resist making myself laugh.... I'm sure there aren't any such minutes).

There are way too many issues with this scenario to address them all on a public forum.

The one thing I would NOT do is prepare the return showing the amounts taken without going thru payroll on the officer salary line.  My credentials are too valuable to me to do that.

Not to be rude, but I suggest you find someone locally to help/mentor you on this OR to take over the client.

EDIT.... I do want to commend you tho @SharonAnn for recognizing that there were issues, and that the prior preparer was doing things incorrectly.

[SharonAnn]

Thank you for all your input!    I do need someone local to help me for sure.

Corporate minutes?      Baaa haaaaa   Omg  I know.   

Thank you again everyone for input 😁 

[qbteachmt]

"There's still time to make things right,"

I sure hope they made lots of money and still have some of it. (penalties, taxes, etc).

Make Right = turn all "draws" into Loans, then offset the loan amount for each year end with one Gross wage payroll for each year end. For both years. Then, 2018 1120 gets amended and personal 2018s get amended. State and Fed employer considerations.

Then, they need guidance for undoing that corporation, and since it was only two years (and only one is filed), it might only hurt a little. We don't know how assets will be affected, for example.

And you would have one QB entity file for that Corporation, without any of their personal activity it in. If they worked together in 2017, none of that activity would carry over to the 0218 file. And if they wrap up that corporation, then you need to start a new file for that new entity that they will be without the corporation existing.

Whew. That should keep you busy.

Good luck.