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Does the three year statute of limitation apply to low salary for s-corp?

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davidan

Junior Member
Due to bad advice of my accountant for the first few years of the S-Corp he set no salary or very low one. Does the three year IRS statute of limitation also apply in my case to prevent the IRS to go and modify my return because of the low/no salary the s-corp gave me?

From what I have read the statute of limitation can be extended to six years when a substantial error is made. It looks like "substantial error" is defined as omitting 25% or more of your income.
 


LdiJ

Senior Member
Due to bad advice of my accountant for the first few years of the S-Corp he set no salary or very low one. Does the three year IRS statute of limitation also apply in my case to prevent the IRS to go and modify my return because of the low/no salary the s-corp gave me?

From what I have read the statute of limitation can be extended to six years when a substantial error is made. It looks like "substantial error" is defined as omitting 25% or more of your income.
Are you saying that you did not pay yourself a salary with proper withholding (particularly social security and medicare taxes) but the profits of your S-corp WERE included on your Schedule K1 and therefore were included on your tax return?

If your business really had little to no profits for the first couple of years (not unusual) then you would not be expected to pay yourself a salary. However, once you start having actual profits you definitely need to be paying yourself proper wages with proper withholding.
 

Taxing Matters

Overtaxed Member
However, once you start having actual profits you definitely need to be paying yourself proper wages with proper withholding.
Just so the OP is clear on this, no provision of federal tax law requires that the S-corporation pay its owner/officer a salary. (There may technically be a requirement to pay minimum wage under federal and/or state minimum wage laws depending on the circumstances, though.) However, the tax law provides that distributions made by the S-corporation will first be characterized as wages to the extent of reasonable compensation that would have been paid to the owner/officer for work he/she has done for the corporation. The problem that occurs here is that if you work for several years for the S-corporation without taking a salary and with no distributions and then after that take a large distribution from the corporation that distribution will be first treated as salary up to the point you will have been fully paid a reasonable compensation for all the work you have done. In short, you end up taking several years worth of salary all at once, which given the progressive rates in the tax code may mean paying much more tax on that income than you would had you paid out salary each year instead.
 

Taxing Matters

Overtaxed Member
Due to bad advice of my accountant for the first few years of the S-Corp he set no salary or very low one. Does the three year IRS statute of limitation also apply in my case to prevent the IRS to go and modify my return because of the low/no salary the s-corp gave me?

From what I have read the statute of limitation can be extended to six years when a substantial error is made. It looks like "substantial error" is defined as omitting 25% or more of your income.
The IRS has 3 years from the later of the date you file the return or the due date for filing the return to assess additional tax. That period may be extended in some circumstances. One of those is that the period is extended to 6 year where the taxpayer omitted 25% or more of his/her gross income from the return.

It’s not clear though what your problem is now. Did you take any distributions from the S-corporation (i.e. did the corporation give you any money or property) in the past few years? Or did you keep everything in the business? Did you report your share of the S-corporation’s income on your personal income tax return (Form 1040)? It would help us help you if you tell us more about the issue you have.
 

davidan

Junior Member
The IRS has 3 years from the later of the date you file the return or the due date for filing the return to assess additional tax. That period may be extended in some circumstances. One of those is that the period is extended to 6 year where the taxpayer omitted 25% or more of his/her gross income from the return.

It’s not clear though what your problem is now. Did you take any distributions from the S-corporation (i.e. did the corporation give you any money or property) in the past few years? Or did you keep everything in the business? Did you report your share of the S-corporation’s income on your personal income tax return (Form 1040)? It would help us help you if you tell us more about the issue you have.
Unfortunately I let my accountant handle everything and now I'm a bit worried that he has really messed up. He did declare all of the income on "my" (personal) return and they were as distributions. I am now on a payroll and getting my taxes withheld but I was not before.

Here is what worries me. I was doing some reading and it seems IRS's statute of limitation on payroll is different for the 1040 form? From what I have read my accountant had to file form 940 or 941, I'm not 100% sure if he did or not . If he didn't then the clock for the statute of limitation never started? But then again from what I read, that was for companies who actually took payroll taxes from their employees and never paid it to the IRS.

I'm trying to find out if the IRS can audit or assess new payroll taxes on me after the three years.
 

Taxing Matters

Overtaxed Member
Unfortunately I let my accountant handle everything and now I'm a bit worried that he has really messed up. He did declare all of the income on "my" (personal) return and they were as distributions. I am now on a payroll and getting my taxes withheld but I was not before.
A S-corporation owner must report his/her share of the S-corporation’s income on his/her personal income tax return (Form 1040) whether the corporation made any distributions to the owner. Distributions occur when the corporation gives out money or property to the share holder on account of his/her shares in the company (as opposed to wages paid for for work done). What federal tax law says is that for a S-corporation shareholder who works for the company any distributions will be treated for tax purposes first like payment of wages up until the point that the owner has received reasonable compensation for the work he or she has done for the corporation. Thus, distributions treated as wages are subject to federal employment taxes (reported on Form 941) and unemployment taxes (Form 940). So the company would be obligated to withhold income tax and the employee’s share of FICA tax (Social Security and Medicare tax) and also pay the employer’s matching share of FICA taxes. The corporation would also have pay those taxes with periodic deposits. The company also pays federal unemployment tax, but for just one employee this tax is very small.

So if your corporation actually distributed any money or property to you and at that time there was work you had done that you still had not yet been paid a reasonable wage for doing that distribution should have been treated like the payment of wages at least up to the point that you had been paid for all the work done. If such a distribution did occur and you did not treat it as wages then yes, your corporation has a problem because it failed to pay the 941 and 940 taxes due for the wages that were deemed paid. Like any other return, the form 940 and 941 are subject to a 3 year statute of limitation for assessment (SOL), but the SOL only starts to run once you have filed the returns. Until you file the returns, the IRS can make that assessment of tax (along with penalties and interest) at any time. It could come after you 50 or 100 years from now for it when no returns have been filed. What you’d need to do is get those returns filed and pay the tax, penalties, and interest due on them to fix the problem. As you presumably have paid the income tax on your profit from the S-corporation what this boils down to is that you’d have FICA taxes to report and pay on the Form 941 and unpaid unemployment tax to report and pay on Form 940. If this is your situation I would advise you to see a tax pro (not the one who screwed it up) to get this fixed.
 

LdiJ

Senior Member
A S-corporation owner must report his/her share of the S-corporation’s income on his/her personal income tax return (Form 1040) whether the corporation made any distributions to the owner. Distributions occur when the corporation gives out money or property to the share holder on account of his/her shares in the company (as opposed to wages paid for for work done). What federal tax law says is that for a S-corporation shareholder who works for the company any distributions will be treated for tax purposes first like payment of wages up until the point that the owner has received reasonable compensation for the work he or she has done for the corporation. Thus, distributions treated as wages are subject to federal employment taxes (reported on Form 941) and unemployment taxes (Form 940). So the company would be obligated to withhold income tax and the employee’s share of FICA tax (Social Security and Medicare tax) and also pay the employer’s matching share of FICA taxes. The corporation would also have pay those taxes with periodic deposits. The company also pays federal unemployment tax, but for just one employee this tax is very small.

So if your corporation actually distributed any money or property to you and at that time there was work you had done that you still had not yet been paid a reasonable wage for doing that distribution should have been treated like the payment of wages at least up to the point that you had been paid for all the work done. If such a distribution did occur and you did not treat it as wages then yes, your corporation has a problem because it failed to pay the 941 and 940 taxes due for the wages that were deemed paid. Like any other return, the form 940 and 941 are subject to a 3 year statute of limitation for assessment (SOL), but the SOL only starts to run once you have filed the returns. Until you file the returns, the IRS can make that assessment of tax (along with penalties and interest) at any time. It could come after you 50 or 100 years from now for it when no returns have been filed. What you’d need to do is get those returns filed and pay the tax, penalties, and interest due on them to fix the problem. As you presumably have paid the income tax on your profit from the S-corporation what this boils down to is that you’d have FICA taxes to report and pay on the Form 941 and unpaid unemployment tax to report and pay on Form 940. If this is your situation I would advise you to see a tax pro (not the one who screwed it up) to get this fixed.
While I absolutely agree with all of this I do believe that the actual amounts on the schedule K1 make a significant difference. If the profits of the company were negligible, then in my experience, the IRS is going to make the assumption that there were no distributions.
 

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