Double Taxation

[ILLMAS]

A new TP came to see me, back in 2007 he formed a corporation to recieve payments as a real estate agent, now in 2010 he wants to do his tax corp tax return and elect to be sub-chapter S, if thought he can make the election the when he is ready to file a tax return. For 2007 and 2008 he recieved a check payable to his corp and he took it out, so now he is on the hook for corporate tax and tax the distribution he took on his 1040. He didn't pay himself as an employee, simply just took out the money. I was wondering if it would be possible for him to request for the 1099's to be amended and instead of paying the corp, paying him? Not breaking any laws of course.

MAS

[JohnH]

Depending upon total income to him and the corp, he's probably just as well off paying tax on the distribution as a constructive dividend and sticking with the facts as they are, double taxation & all. He may even be better off.

If he reports the distributions as Schedule C income, then he pays 15% S/E tax and regular income tax on the earnings, even though the corp gets to deduct the 1099 payments to him. But if he lets the corp report the income then the corp tax rate is 15% (roughly the same as the S/E tax), and on his personal return he gets to treat the constructive dividend as a qualified dividend subject to the lower tax rates. The only down side is that he won't get SocSec earnings credits for the two years. (This could be a major issue or it may not matter at all - just depends upon his total filing situation, age, etc)

Of course, if the income is very high and his corp jumps well into the 25% bracket, or if his personal income exceeds the SocSec maxiumum, or if he's subject to AMT, then all the above could change drastically. State considerations might also affect the total outcome as well.

Running a dummy return using round numbers would give you the difference, but it's likely you'll quickly discover that the double taxation really doesn't matter from a net cash standpoint when all the dust settles. And reporting things as they actually occurred, coupled with getting it right from this point forward, might go a long way in getting a quick resolution if he gets tagged for an audit. Sometimes an auditor will reward straighforward reporting, whereas they can get downright testy when there's been a lot of creative reclassification.

[jainen]

>>he can make the election the when he is ready to file a tax return<<

You can research the few ways to make a retroactive S election, but in general you are not allowed to use hindsight to figure out whether it will save taxes. The best way to show he had always intended to be an S-Corp is to have reported the net income on his timely filed 1040s AS IF it had come from an S-Corp, even though the corporation did not issue K-1s yet. Even with that, it helps to have a strong and genuine reasonable cause for the late election, such as external forces over which he had no control.

I would be especially skeptical if the plan is to pass through business losses, or if the taxpayer has anything less than excellent records. In evaluating the different tax rates that may apply, don't forget to consider late filing, late payment, and estimated tax penalties. And of course, your own professional fees.

As real estate is a fairly straightforward sort of business (no inventory, only a few income and expense categories) with lots of professional support for good business practices, I recommend a pretty high standard for those past-year records. In particular, I recommend you deal fairly with the payroll issue. A corporate officer is an employee by definition, and obviously the earnings came from his own personal service.

Your original question about amending the 1099s conflicts with my excellent records advice. I doubt the R.E. broker would tolerate it because it would surely invite the IRS to take a closer look at HIS books.