Corporate tax questions

[allfiredup]

I live in Georgia.

I work for a small S-corporation and have a few tax questions.

Prior to S-corp selection in 2001, we were a C-corp. The owner would take money without paying any tax on it or without it showing on his W2 or 1099. On the balance sheet, they show as loans to him. The sum is well over $500k.

Obviously, this could be a nightmare if the IRS finds out. Is there ever a situation where an employee or officer of a company could be given an "advance" and it not be taxed at the time it is paid? Regardless, that doesn't matter in this case, it's obvious that he owes Federal and Georgia tax on every penny of that money. Correct?

The other question relates to Georgia tax law. We realized a few years back that Georgia imposes a corporate tax on the net income of the company. While this is the norm for a C-corp, it doesn't make much sense for an S-corp. We were being double taxed by Georgia on the same income- once as his earnings and again as corporate net income tax.

We now convert net income to his payroll earnings and, as a result, net income shows as ZERO at year end. This is done so there will be nothing for Georgia to tax. Since the income does show on the owner's W2, we pay state income tax on it for him personally. Is what we're doing (ZERO-ing out net income so we won't be taxed) legal? As I said, tax is being paid on his personal income, but there's something that just feels unethical about it.

Any input? Thanks!

 

[LdiJ]

I live in Georgia.

I work for a small S-corporation and have a few tax questions.

Prior to S-corp selection in 2001, we were a C-corp. The owner would take money without paying any tax on it or without it showing on his W2 or 1099. On the balance sheet, they show as loans to him. The sum is well over $500k.

Obviously, this could be a nightmare if the IRS finds out. Is there ever a situation where an employee or officer of a company could be given an "advance" and it not be taxed at the time it is paid? Regardless, that doesn't matter in this case, it's obvious that he owes Federal and Georgia tax on every penny of that money. Correct?

Not necessarily correct. Corporations can make loans to employees and stockholders. However, if he never pays the money back, or the corporation never officially forgives the loan as a distribution to him, then it could get tricky. If I were advising a client, I would tell the client to take 50-100k a year as distribution (the corp forgiving 50-100k per year of the debt) until its gone.

The other question relates to Georgia tax law. We realized a few years back that Georgia imposes a corporate tax on the net income of the company. While this is the norm for a C-corp, it doesn't make much sense for an S-corp. We were being double taxed by Georgia on the same income- once as his earnings and again as corporate net income tax.

We now convert net income to his payroll earnings and, as a result, net income shows as ZERO at year end. This is done so there will be nothing for Georgia to tax. Since the income does show on the owner's W2, we pay state income tax on it for him personally. Is what we're doing (ZERO-ing out net income so we won't be taxed) legal? As I said, tax is being paid on his personal income, but there's something that just feels unethical about it.

There is absolutely nothing shady or unethical about a corporation paying its entire net income as salary to its single shareholder. In fact, Congress and the IRS prefer it that way, because a greater portion of social security and medicare taxes get paid that way.

 

[allfiredup]

Thanks!

Not necessarily correct. Corporations can make loans to employees and stockholders. However, if he never pays the money back, or the corporation never officially forgives the loan as a distribution to him, then it could get tricky. If I were advising a client, I would tell the client to take 50-100k a year as distribution (the corp forgiving 50-100k per year of the debt) until its gone.

If 50-100k per year was forgiven from the balance he has borrowed, wouldn't he be responsible for paying income tax on the amount forgiven each year?

As far as making loans to employees, when would you draw the line? Couldn't you theoretically borrow you gross salary each month and not pay any tax as a result? I guess my question is where the IRS would stop considering it a loan since it hasn't been and won't be paid back?

Thanks again for your input!

 

[LdiJ]

Not necessarily correct. Corporations can make loans to employees and stockholders. However, if he never pays the money back, or the corporation never officially forgives the loan as a distribution to him, then it could get tricky. If I were advising a client, I would tell the client to take 50-100k a year as distribution (the corp forgiving 50-100k per year of the debt) until its gone.

If 50-100k per year was forgiven from the balance he has borrowed, wouldn't he be responsible for paying income tax on the amount forgiven each year?

Yes, I said "forgiven" as a distribution. Since it would be a distribution from Accumulated Profits and Earnings from the C Corp years, it would be taxable as dividends.....just as it would have been at the time...and just as it would be now if the distributions occurred now.

As far as making loans to employees, when would you draw the line? Couldn't you theoretically borrow you gross salary each month and not pay any tax as a result? I guess my question is where the IRS would stop considering it a loan since it hasn't been and won't be paid back?

Of course it could be abused...and apparently has to some extent in this case. I can't guess whether or not the IRS would specifically decide that it had already gone too far or not. Hoping to collect a reward for getting your boss in trouble? I wouldn't count on it just yet.

 

[allfiredup]

Yes, I said "forgiven" as a distribution. Since it would be a distribution from Accumulated Profits and Earnings from the C Corp years, it would be taxable as dividends.....just as it would have been at the time...and just as it would be now if the distributions occurred now.



Of course it could be abused...and apparently has to some extent in this case. I can't guess whether or not the IRS would specifically decide that it had already gone too far or not. Hoping to collect a reward for getting your boss in trouble? I wouldn't count on it just yet.

I'm resigning effective 3/9/06, so I had actually given some thought to tipping off the IRS. I'm going to work for one of our largest clients and my boss isn't going to be happy when he finds out. I'm thinking that this information might actually be useful to keep him off my back. No direct threats, of course, that'd be a slippery slope.

 

[LdiJ]

I'm resigning effective 3/9/06, so I had actually given some thought to tipping off the IRS. I'm going to work for one of our largest clients and my boss isn't going to be happy when he finds out. I'm thinking that this information might actually be useful to keep him off my back. No direct threats, of course, that'd be a slippery slope.

Your crossing a slippery slope in general....with both bosses. Your new boss won't be impressed with your loyalty.