Question on distribution on schedule k-1

[tagteam]

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@yekasi wrote:

Q1) So this 130k will flow into my personal tax return in total?

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Yes, the entire $130,000 will flow to Line 1 of your K-1. The $54,000 in W-2 wages would not be deducted from business income.

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@yekasi wrote:

Q2) if I make a $70k distribution to ShareHolder1 in TurboTax Business - will this means I only have to report 60k as personal Income or do i still have to report full $130k?

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You would report the total ordinary business income of $130,000; the distribution would not be deducted from the business income you would have to report from Line 1 of your K-1.

[yekasi]

@PatriciaV 

RIght, i understand that. I was trying to validate what happened to me in 2020 was correct or not (more as a FYI to myself for educational purpose).  Do you know the answer to that?

From what I read - I thought as long as I have a reasonable W2 salary from my SCOrp - the remaining profit of the SCorp are not considered taxable income to anyone.  Eg. 186K  profit with 56k expense/deduction.   That means 130k AGI.  And then 54k reasonable salary - the remaining 76k is not a taxable income and can be tax free income to shareholder. (myself).  Is that not the case? This was the only purpose why i did the W2 wages to myself.

[yekasi]

@tagteam Thanks.  So what happened to me in 2020 seems to be the correct thing (or perhaps the only thing i could due as there was no salary).  In regardles to what PatrickV mentioned below, it seems to contradict to what we said in the earlier post - did i misunderstood what PatriciaV mean?

[tagteam]

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@yekasi wrote:

......did i misunderstood what PatriciaV mean?

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I think you misunderstood. @PatriciaV stated:

The income from your S-Corp (including Box 1 from Schedule K-1) is also taxable income on your personal return.

That statement is correct and @PatriciaV, I believe, was making the point that you will report income that appears on your W-2 and income that appears on Line 1 of your K-1.

[Critter-3]

If you work for the company  you  must take a wage and file quarterly payroll tax reports, the annual reports and issue a W-2 in January.  If you are not yet doing this you could be in for big surprise when the IRS tells you all the K-1 box 1 income is now to be SE income and you owe years of SE taxes that were not taken ... it is an expensive error to make.   The old CPA should have educated you on this issue years ago. 

The IRS position is that an S-Corporation MUST pay a reasonable compensation to an officer before non-wage distributions may be made.  The reason is that they feel that non-wage distributions when no wages are paid is an avoidance of social security taxes.  From the IRS website at http://www.irs.gov/businesses/small/article/0,,id=203100,00.html :

"Reasonable Compensation

S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly.

Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for the service rendered to the corporation.

Several court cases support the authority of the IRS to reclassify other forms of payments to a shareholder-employee as a wage expense and subject to employment taxes."

The page cites Joly vs. Commissioner, 211 F.3d 1269 (6th Cir., 2000) as one judicial finding on the IRS's authority to reclassify distributions to wages subject to employment taxes.  Factors to determine reasonable compensation are given in the ruling.

The AICPA has an interesting article on this topic here: http://www.aicpa.org/publications/taxadviser/2011/august/pages/nitti_aug2011.aspx

You also might want to read a lively discussion on the Tax Almanac website here: http://www.taxalmanac.org/index.php/Discussion_Forum_-_Tax_Questions .  The substance of the discussion seems to be that taking a reasonable salary is not optional and, if you took distributions with no salary, the distributions should be changed to salary with appropriate employment tax returns being filed (late, if necessary.) 

The fastest way to get audited as an S-Corporation is to not report wages to officers on page 1 of the return.

[yekasi]

@tagteam 

> That statement is correct and @PatriciaV, I believe, was making the point that you will report income that appears on your W-2 and income that appears on Line 1 of your K-1.

I guess i am not on this statement - if i have to report both income on my W-2  **and** line1 of my K-1.  Isnt that essentially reporting the full $130k and there is no tax free distribution?  I thought i only have to report 54k as W2 wages, and the other 76k is omitted and I do not need to pay any tax on that.  

[AliciaP1]

Distributions and net income from your pass-through reporting business are never tax-free. As an S-Corp, you are reducing your total tax liability, but you cannot eliminate it altogether.

If you were filing your business as Schedule C income, your entire net income including amounts you paid yourself, would be subject to self-employment tax (which is actually Social Security and Medicare taxes) as well as be taxed at your personal tax bracket rate. 

Since you are filing as an S-Corp and have paid yourself a W-2 salary, only the salary is subject to Social Security and Medicare taxes.  Both your W-2 income and your net income from the business are then taxed at your personal tax bracket rate.

You can find instructions on Schedule K-1(Form 1120-S) here.