Question about S-Corporation Employeement Requirement (is it legal to have 0 employee in S-Corporation) in California

[mitch_gmail_02]

Hello,

I had a S-Corporation. I am the owner and the one running it. 

It is a small business start recently and so not enough profit to pay for any employee (only enough to continue the business funding etc...), so I am the owner but not an employee and not take any money out from company yet (no divdends etc).

It seem it is okay when I filed for Tax 2019/2020.

But I looked up somewhere in TurboTax while filing for my 2020 taxes (sorry miss where it was located, but I think relate to CA Form 3554), Turbo Tax mentioned start from 2021, S-Corporation must filed for New Employment and that amount and benefit must be "suitable" for the work.

I deleted the Form 3554 from my 2020 Tax to finish the filing.

However, as the business was just started (and last year was even a loss), so will not able to pay for employee (even myself) a "suitable amount" (even the minimum wage required in CA) .

But after searching to IRS/other forms, I did not see any direct law/tax indicated that S-Corporation must have at least one employee.

I am willing to pay the additional income tax. For 2020, the TurboTax Business 2020 just directly place the aggregate gross receipt from the gross income of business. Even though business revenue is at loss due to spending vs sales) (not sure if that is what pass-through mean? As this was not the case when I filed 2019 tax with Turbotax Business 2019.

But I just want to confirm is it still legal to have 0 employee as of 2021 in California for S-Corporation?

[LudwigVan_fan]

First, I cannot answer the question in regards to California.  Generally speaking though, the election to be a "S" Corporation, is at the Federal Level.

At the Federal level, there is no requirement for employees, per se.  However, if an owner, takes money out of an S corporation, and that owner performs work for the corporation, then the question becomes is the money taken out salary/wages, or a distribution?  The Federal Government will and has made cases out of owners/officers that don't take a salary/wage, but do take distributions, cases that these are actually wages.

However, for there to be an issue, money has to be taken out of the corporation by the owner/officer. 

I do not know about California...but most states follow the federal rules guidelines.

The Form 3554 is a form for claiming credit on California taxes in regards to wages/salaries.  It does not effect Federal filing. 

Perhaps someone else can speak to California rules.

[Mybesttaxservice]

Per law, IRS does not require S Corp have an employee

But the IRS requires you (officer) have reasonable compensation based on industry income such as accountant, real estate, life insurance, etc 

If you have loss, then no thing you can do. But the S Corp has loss several years, then the business activities  look like a hobby. Somehow, some one has certain wages from employer and tries to run the business for additional income and keep license active and gain knowledge. That is normal case

The last time, I had meeting with CPAAccademy about this issue 

Some small business S Corp have option to reduce payroll service's fee by issuing officer (yourself) 1099NEC the end of year and pay self employment instead payroll if S Corp has profit .  

Hope this help

[AmeliesUncle]

---

@Mybesttaxservice wrote:

Some small business S Corp have option to reduce payroll service's fee by issuing officer (yourself) 1099NEC the end of year and pay self employment instead payroll if S Corp has profit .  

---

No, that is NOT allowable.   The law says an officer of a corporation is an employee, not an Independent Contractor.

[Mybesttaxservice]

Thank you to share info 

I myself have not sure about it 

But the reality it is the same  for a single member S Corp: W2 or 1099NEC, they have to pay self employment

tax . And the business entity does not have to pay UI and Worker Compensation for the officer per labor law 

When I attend with CPAAcademy and we discuss about it. They are CPA, tax attorney and agree about issue 

But I will listen to you and pay attention for it 

[LudwigVan_fan]

@Mybesttaxservice    Please consider this

https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-employees-shareholders-a...

https://www.law.cornell.edu/cfr/text/26/31.3121(d)-1

(b) Corporate officers. Generally, an officer of a corporation is an employee of the corporation. However, an officer of a corporation who as such does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration is considered not to be an employee of the corporation. A director of a corporation in his capacity as such is not an employee of the corporation.

[AmeliesUncle]

---

@Mybesttaxservice wrote:

When I attend with CPAAcademy and we discuss about it. They are CPA, tax attorney and agree about issue 

---

If a CPA is actually TEACHING that false information in a Continuing Education class, they need to have their license revoked.

[Mybesttaxservice]

Hello 

I know the differences are between employee and independent contractor and distribution 

In the situation single member S Corp officer, under W2 and 1099NEC,  the officer would  pay for self employment the same . No thing change 

Example

Under W2: the S Corp and employee each has paid for 6.2% for FICA and 1.45% Medicare 

Under 1099NEC: the officer has paid the same 15.3% for self employment 

The important that the wage /compensation must be reasonable and not variances from industry income

That is why they and I have agreed. Even though the case has been audited, the tax has not change

Am I correct?

But I agree with you, for the safe way to avoid the problem, I would recommend S Corp officer has W2 if the business entity has profit 

[Rick19744]

I seriously can't believe we are having this discussion. 

While there may be some individual(s) incorrectly taking that position (issuing a 1099-NEC), it will certainly not hold up if audited or goes to Court:

• While at the end of the day, the bottom line may not change, what does change is that the payor is not correct and opens the door for numerous amended returns and penalties.
• The IRS is clear in FS 2008-25 that corporate officers are specifically included within the definition of employee for FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax Act) and federal income tax withholding under the Internal Revenue Code. When corporate officers perform services for the corporation, and receive or are entitled to receive payments, their compensation is generally considered wages.  The only time that this may fall outside the scope of "wages" is when an employee performs services that are outside the scope of what a typical employee is responsible for handling.  An instance is if a part-time employee who handles accounts receivable, also has a side business that performs IT services to businesses.  If that individual then performed IT services to the company, then a 1099-NEC may be warranted.
• Paying an employee (or officer in these facts) via a 1099-NEC will open the door for an IRS agent to require the S corporation to amend the 1099-NEC (reporting zero) and file a W-2.  This means that there will be late filed payroll reports and deposits and penalties.
  • The S corporation will now need to pay the unpaid corporate FICA and Medicare
  • The IRS will charge interest
  • The IRS will assess penalties
  • The individual will now need to amend their tax return to eliminate a Schedule C and report W-2 wages
  • There could be a penalty for failure to file a W-2
  • There will then be state filing changes as well
• Not an exhaustive search, but certainly not what this provider of accounting and payroll services suggests
  • https://support.businessasap.com/article/61-s-corp-payroll-colorado
• And another discussion of the matter
  • https://www.linkedin.com/pulse/w-2-1099-shareholder-employees-corps-paul-s-hamann?trk=articles_direc...

[mitch_gmail_02]

Hello,

I am the owner of the original thread, sorry for late response.

Thanks for all the info and advices. Will take these into consideration.

For clarification:

1. As an officer, I did not take any money out from the S Corporation (so no payment make to me as an individual for service (so no yearly distribution/stock/dividends etc.), and therefore no "not report money") so far (due to reason report in #2). So in that regard, that is why I originally thought it is okay (as the law only mentioned "any payment for services performed", but as there is no payment in any form.)

2. Regarding, why IRS so far do not consider the business as hobby is because the business did have some revenue years previously, just by small margin (and not enough even to pay me as an individual with "reasonable wage" (i.e. CA's minimum wage)). 

So it is kind in grey area that the business will be at loss if we do make a payment to employee (myself) at "reasonable wage" according to law. My hope is eventually the business will "grow" to reasonable degree to fully able to hire, but may take sometime. I established S-Corp due to the business is a hardware business, so has some legal liability cover about product etc.

[Rick19744]

A follow-up to your responses:

• If your S corporation is just breaking even or experiencing small losses, you don't need to worry about the payroll matter at the moment.
• Having said that, if audited, the IRS may scrutinize this as being more of a hobby.  Just keep that in mind.
• Once you do begin to be at the point where you are making $$, and are able to pay yourself, just make sure you pay yourself a wage (W-2) and not just distributions (and not with a 1099-NEC).  You may want to get some tax advice from a professional at that point.  Not only for guidance on a reasonable amount, but you may need help with the payroll tax matters.
• The key is that the IRS doesn't want to see all distributions and no wages being paid out by the S corporation.  No wages, or small wages, can potentially lead to an IRS trigger point

[LudwigVan_fan]

@Rick19744 

One thing to keep in mind for a corporation as opposed to Sch C or Sch F, is that it is "deemed" corporations are created for profit.  In an intense situation it may not "hold up", but it is a big factor in favor of the taxpayer.

Depending on the business of the corporation and how business might be conducted, may have to watch out for disregarded entity and/or personal holding company...but PHC wouldn't fit for an S corp.

[Rick19744]

@LudwigVan_fan I agree that the hobby loss rules are not applicable to C corporations.

However, Section 183(a) specifically states "In the case of an activity engaged in by an individual or an S corporation, if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed under this chapter except as provided in this section."

As such, that is why I noted this could be an issue if audited.