S Corp - no contribution, no separate bank account

[anaban]

I have a customer that opened a S Corp in 2021. Did not use a separate bank account, did not take salary, did not make a contribution to S Corp. 

60k income, 80k expenses. Is it fair to have 20k contribution (difference between income/expenses), -20k net loss and no salary/distribution? Just because I need to have something on the tax return. 

Second option will be 0 contribution, 80k net loss and 60k taxable distribution (since 0 basis) but that looks too extreme. 

I can't find any IRS guidance on this real world situation, but I’s sure he’s not the first.

[dkh]

Did this client have a business - sole proprietorship - before setting up the SCorp?    If yes, maybe this business activity should be reported on the Sched C since client clearly wasn't doing transactions as an SCorp. File the 1120S with zero activity for 2021 then make this client understand what is required for 2022 (payroll, corporate bank account, etc)

Does the client have an SCorp election acceptance letter from IRS?

How did the client have a $20k loss without putting money into the business?

[qbteachmt]

"did not make a contribution to S Corp."

I agree with the analysis as to whether the S Corp was "in business" yet, because how can you "do business" without any assets or resources? What you also need to do is examine those expenses, because a person like this will attempt to run everything through the business that they think can possibly be termed as Business, and a lot of that will be personal.

And right now is a good time to find out why the S Corp was formed. We've seen a lot of bad guidance on this. There still is time to dissolve that concept.

"Is it fair to have 20k contribution (difference between income/expenses), -20k net loss and no salary/distribution?"

There is no Fair, in IRS terminology.

[anaban]

It's a new business, no prior activity. He does have activity, just all the income and expenses are mixed with personal, he used his personal bank account.

I removed all the personal expenses. At the end of the year he spent about 50k out of his personal account for the business and received 20k. So for the first year, a 30k loss.

For contribution:

 Should I record 50k as an initial "shareholder contribution" (total amount spent) or 30k (difference between income and expense).

For distribution:

Since the payments received went directly in his personal account what is the amount of distribution? 20k total payments received for the business? Or 0 since the business had a loss?

[IRonMaN]

But you didn't answer dkh's question - did he receive an acceptance from the IRS to become a S corp?

If so, it sounds like he has a schedule C for the year and a S corp with zero activity.  If he didn't receive the acceptance, he just has a schedule C.

[qbteachmt]

"He does have activity, just all the income and expenses are mixed with personal, he used his personal bank account."

That's not the issue. The issue is "Who" had the activity? Because an S Corp is its own entity, separate from the shareholders.

[BobKamman]

"I can't find any IRS guidance on this real world situation"

That's like saying you can't find any fire department guidance on what to do with the building you put up without the required sprinkler system. 

OK, I'm sure @IRonMaN can come up with a better analogy. 

Tell us specifically what actions your client took, when.  Corporation or LLC? EIN requested?  Form 2553 filed?  First business activity?  First income received? First expense paid? 

Some businesses don't require any initial capital.  But the $20K deficit suggests both capital and shareholder loans would be involved.  Let me guess, he went to a seminar and decided he could DIY.  He probably should continue with that attitude, and do his own tax returns.  Or at least, not get you involved. 

[anaban]

No, it's worse than that, I just did not want to load you with the full picture: he’s gen Z, opened a Delaware C Corp (CA resident) just because saw it on YouTube. I'm serios. 😊

So as of now he is a C Corp, no acceptance letter, I will file 2553 (late) with his first S Corp return. So no  schedule C.

He it's a reseller - purchased some items on 2021 for 50 k total, stores them on a warehouse and sold a few for 20k.

Problem is that he is family, and broke, so I can’t pass it to “the CPA”. I’m a bookkeeper, I have fair tax knowledge but this is above my pay grade.

[BobKamman]

Gen Z would never rely on YouTube.  He should have depended on TikTok, doesn't take as long to screw up. 

So he wants to expense inventory?  I always have to look up the rules on that because it's like same-sex marriage, contrary to what I was taught when I was young.  

[qbteachmt]

"purchased some items on 2021 for 50 k total, stores them on a warehouse and sold a few for 20k."

Then there is no loss, yet. He has stock on hand. That is asset value, not expense as loss.

"So as of now he is a C Corp, no acceptance letter, I will file 2553 (late) with his first S Corp return."

Why? Why not just dissolve the C Corp for that one year with all 0? Forming an LLC and then trying to be a corporation would be different. Forming a corporation might show an intent, but the person did nothing as/for the corporation.

[anaban]

I will convey your advice. May be I can even ask him to search a tax solution on TikTok: S Corp taxes funny videos?

No, that part at least is easy - big items, just a few electric tractors, not a big inventory. Not a bad idea actualy, it may work, its just a bad start. 

[anaban]

Yes, we discussed about that: dissolve the C Corp. But he has big dreams, thinking about taking investors, etc so I convinced him to swich to S Corp. It’s just so cool to have a Delaware Corp 😊

You are right, it may not be a loss . I did not look at the actual label on expenses, it they COGS/inventory or actual expenses. I guess I need to put all in QB and see what I get after that.

And he may have profits for 2022. A smart kid just needs some guidance.  

[qbteachmt]

"so I convinced him to swich to S Corp"

But you don't have that now, and you don't have that for 2021, and it's not automatically retroactive, and you don't even have grounds for a late election, since there was no "acting as" involved for this person. You likely can deal with 2021 as 0 for 1120, and then file his personal taxes accordingly.

[anaban]

Oh I got it. So what you’re saying that because he never did his homework and never made a contribution so his S/C Corporation, never opened a business account and separated himself for the business he has no grounds of showing that he has an actual corporation.

Or rather he will have a 0 1120 for 2021and 2022.  And have this period on a schedule C.

And then formally open a bank account now, make a contribution to S Corp and transfer the assets from LLC to S corp. And send 2553 to apply for S Corp. 

I don’t think I can do that. Any idea how much an CPA will charge to for the LLC-S Corp transfer?

I will try to persuade to keep the schedule C until he can afford to pay for that. Thanks for the help. 

[BobKamman]

For a discussion of expensing inventory by small businesses, see

https://www.eisneramper.com/inventory-tax-blog-0919/ 

[sjrcpa · Accepted solution]

What LLC?

I'd tell him to just keep and use the Schedule C. If/when it looks like his big dreams will come true, tell him to hire a lawyer and a CPA to get everything set up properly. An S Corp is useless if there will be venture capital money.

[qbteachmt]

"and transfer the assets from LLC"

This is very confusing to anyone trying to follow along. The title of the topic is S Corp, but it turned out there is only a C Corp formed. The future proposal was to elect S Corp. Now you are telling us there is an LLC, as Single member? You do realize every one of these entity types has specific requirements, and when you keep changing the terminology, you really are starting over with the scenario.

What you should be doing is presenting and acting on facts. Not supposition or proposals. This is mid-2022. There is the need to address 2021, which is in the rear view mirror. There is the need to address 2022 before it is too late.

You likely need to pass off all the tasks you are not familiar with.

[anaban]

Schedule C and 0 1120 for now. If he will make it big we all get a piece of it since it was a colaboration. Thanks for your help.