Partner uncompensated, EDD payroll audit, and more!

[Strongsilence-CPA]

An individual in business with an S Corp owner has been paid by him on 1099 for last 2 years. (I have had the account for the 2021 and 2022 returns.)  She says he made a verbal promise to make her a co-owner and she says she is owed 250K.  They both have business attorneys, but she says it is not litigious. 

In the meantime, the EDD is challenging the contractor classification. I have not talked with EDD nor seen EDD letters. Sounds like they want payroll taxes.  (Lesson to me to closely analyze worker classification prior to taking new clients. There were signs that they were playing loose with wages.)

She thinks she can argue that she was actually a shareholder rather than an employee.

She wants to get a certified valuation advisor to see if her possible ownership interest would compensate her for the 250K compensation.

She says she wants amended Scorp returns to reflect that she was a 50% owner. I explained that she'll have big tax liabilities from investment income. She countered that they agreed that she would only have the tax losses from operations. (Rental real estate (apt) management.)

I am not doing anything until an agreement is done and signed.

[sjrcpa]

"I am not doing anything until an agreement is done and signed."👍

Does she know  a shareholder of an S Corp is also supposed to be an employee if she works for the business?

EDD will assess unemployment tax, right? How much can that be? A lot cheaper the including 50% of the S Corp's income, probably. 

"I explained that she'll have big tax liabilities from investment income. She countered that they agreed that she would only have the tax losses from operations." S Corps don't work that way. If you're a 50% shareholder, you get 50% of everything.

[Strongsilence-CPA]

"Does she know a shareholder of an S Corp is also supposed to be an employee if she works for the business?"  I told her. She doesn't want to pay herself wages for those years. She would rather risk an IRS audit in order to get out of this EDD wage classification audit.

"S Corps don't work that way. If you're a 50% shareholder, you get 50% of everything." Thank you. I was thinking of partnerships.

I think she needs to start a new company mainly to be clear of legal and tax liabilities.  The other guy can compensate her without selling or gifting stock to her of the old company.

[Karl]

---

I am not doing anything until an agreement is done and signed.

---

And a hefty retainer is paid.  Yikes! Are you sure you want this person as a client?

[qbteachmt]

Break it down:

"Partner"

Not a Partner. Either working for the person, or working independently. As you note, worker misclassification (under whose control, using whose resources, who is at risk financially if the work is done wrong) is a separate consideration.

"uncompensated"

So no proof that this work was anything other than "my hobby time as a volunteer?" What the heck is on that 1099, which type of 1099, and does she have other "clients" like this one? What type of tax return has she been filing for that work?

"EDD payroll audit, and more!"

Yes, and the IRS can asses penalties and interest, so they are not to be ignored.

"An individual in business with an S Corp owner"

Why do you use "partner" and "in business with?" What is this relationship? What is the work?

"has been paid by him on 1099 for last 2 years."

So there has been compensation.

"She says he made a verbal promise to make her a co-owner and she says she is owed 250K."

But she also was paid? How is there this value owing, then?

"In the meantime, the EDD is challenging the contractor classification."

They are unemployment and disability and sick/family leave. They are not always right. Does she run her own business, and the work she was doing falls under it, and she would already have either a relationship with EDD or some sort of waiver or exemption with them due to her own business? Did you do her prior years taxes?

"I have not talked with EDD nor seen EDD letters. Sounds like they want payroll taxes."

I've posted this before, and use it in my payroll class. Willie Nelson's band was hired to play one summer festival in a small town in Montana, and our State Fund (disability) pursued that this should have been a W2 employee relationship. The State lost.

"She thinks she can argue that she was actually a shareholder rather than an employee."

There is no "rather than" in an S Corp, if you are doing the work of the business. There is a two-hats person: Shareholder-employee. Because the point of the corporation is that it cannot do its own work.

"She wants to get a certified valuation advisor to see if her possible ownership interest would compensate her for the 250K compensation."

That entire thought process makes no sense for the stated goal. Yes, someone can be hired to find if there is some value in their agreement, if they agree on the intent of their agreement. Then, that value would be treated as a Barter, if you mean, trade the valuation for ownership shares. The Barter is a taxable event, and the value of that payment is no different than if it had been paid in money. It's still a problem for classification.

"She says she wants amended Scorp returns to reflect that she was a 50% owner."

Ha ha ha...

"I explained that she'll have big tax liabilities from investment income."

You mean, the K-1 to the only shareholder would be split to the two of them.

"She countered that they agreed that she would only have the tax losses from operations. (Rental real estate (apt) management.)"

You can't do that. And you still have the Earnings from that valuation to deal with as taxable compensation.

"I am not doing anything until an agreement is done and signed."

Are you even the right person to take on this project?