S-Corp: Recharacterize shareholder distributions as wages while doing 1120-S

[Kevin1]

I'm doing an (extended) 1120-S on a very small S-Corp, shareholder / owners.    Instead of doing payroll to pay  themselves, they mistakenly wrote owners draw checks, no withholding, no quarterly filings.  

I should recharacterize much of this as reasonable salary when I file 1120-S.   What is the best (lowest penalty) way to do this now, so far after the 941 deadlines?

[poolcleaner · Accepted solution]

Are the payment times able to let you report all the income in the 4th quarter? The later the time in the year the better off they are.  If they have been paying themselves correctly in prior years, then file them correctly for the entire year. You could try to see if the IRS would remove the penalties (probably not likely but always worth a try).  The next thing to do is to be certain they file correctly in 2019. 

[Kevin1]

It was the first year for them.

[poolcleaner]

It is always worth a try to plead ignorance and they are good people who are trying to do the correct way but it will probably not work. If that doesn't work, I'd try an appeal.

[radfordtaxes]

I have a similar situation, new client comes to me to file her 1120S.... no extension or anything... No payroll to cover the reasonable compensation. (first year filing for her 1120S) two shareholders.

They received 1099 NEC in corp name for approx 48,000. 

Is there any fixing this? Or just take chances on it?  or as with previous question, file past due 941 fourth qtr and pay penalties..... or anyway compensation could be labeled as self employment income on the k-1 to be taxed as such? 

I have been playing around with the numbers and I am not getting anything to fall into place that would cover the shareholders behinds.... and of course I have already created/filed 2nd quarter payroll  reports for 2021. 

[BobKamman]

Would have been better to start a new message thread for this, rather than reviving one from two years ago.  What you don't tell us is what they did with the $48K -- presumably, just paid it out to themselves?  

I would inform the clients that IRS audits 1 in every 358 S Corporation returns, and let them decide how much of the distributions were reasonable compensation, based on all of the facts and circumstances.  And, I would examine whether it could be reported on a 1099-NEC to them, rather than messing around with delinquent 941's.  Is there really an employer/employee relationship?  

[qbteachmt]

"They received 1099 NEC in corp name for approx 48,000."

Are you describing that the corporation created a 1099-NEC for the shareholder? You cannot be a subcontractor to your own corporation that you also did the work for. Being a subcontractor would mean there is yet another "entity" under which they did this work, which is not true. Is there one 1099-NEC or two (one for each person)?

Or, was that issued to the corporation by a client?

And how does $48,000 related to all of the corporation's revenue? Or, again, is this the "drawn" amount, by one, the other, each, or both people? Detail really matter.

"or anyway compensation could be labeled as self employment income on the k-1 to be taxed as such?"

Absolutely not. A K-1 from their corporate entity will not supply SE income to them. Their labor is part of the costs for the corporation, reflected in payroll. Of all the ideas, this one is the least possible. And you already stated there was no compensation.

If they both worked for the business, I would bite the bullet and do a year-end payroll. That doesn't means using the $48,000 value. That means doing what applies, correctly.

[radfordtaxes]

the 48,000 NEC was from the one and only client. The first year they worked for this vendor, they filed separate schedule C's....claiming about half of the total made as income, no expenses.  Then the husband was apparently advised to create an entity...about Feb. 2020.

  I was called in by the soon to be ex-wife...about a month ago.... to file necessary taxes. 

First year 1120 S.  and then personal return. 

Yes I suppose a new thread would have been the correct way to post. I was attempting to find an answer through posts - 

[qbteachmt]

"the 48,000 NEC was from the one and only client."

That means they didn't submit a W9 showing their corporate status, then? But you stated it is in the name of the corporation. That didn't have to be issued a W9 at all, but now that there is, your client has what I call, "Discoverable" info on file with the IRS.

I don't see where you mentioned what happened to that $48k, or if they took distributions from the entity?

"The first year they worked for this vendor,"

You mean Customer. Vendors are the people who provide you with goods or services; they are a Vendor to that Customer of theirs. They worked for a customer and got paid by a customer.

"they filed separate schedule C's....claiming about half of the total made as income, no expenses."

Well, maybe they don't have any costs. That's possible. But a corporation should show payroll expense and employer taxes.

"First year 1120 S.  and then personal return."

It's not unusual for the client to have gotten either bad guidance, incomplete guidance, or the client just doesn't follow through.