S Corp payroll

[PMT_2021]

I started an inc in Nov 2021 (approved article of incorp thru state), got EIN and filed 2553 for s corp status in Dec 2021, effective 1/1/2022. Now i only had expenses in 2021 so i plan to file a zero return 1120 for 2021. Im trying to hire a CPA to do payroll etc and file taxes, withholding etc. Now one CPA told me if you start slow and are not expecting any major income in Q1-22, you dont need to do payroll. A K-1 can be filed. Basically if the income is small in the beginning, he said you dont need a payroll.

My question is, i thought for an s corp payroll was mandatory. Also, i thought you dont need monthly payroll, quarterly is acceptable. Can anyone guide me if this CPA is correct as far as filing K-1 goes. Because he seemed  to be more trustworthy and not as expensive as others. 

[Mike9241]

according to the IRS you have to file an 1120 for 2021

from 2020 form 1120 instructions

Who Must File
Unless exempt under section 501 (it isn't), all domestic corporations (including corporations in bankruptcy) must file an income tax return whether or not they have taxable income. so you must file a 2020 1120.

note, if the corp began business in 2020 then the expenses must be taken on the 2020 return. since you converted to S-Corp there would be no tax benefit. 

start-up expenses are taken in the year the corp began business as follows

$5,000, reduced (but not below zero) by the amount by which such start-up expenditures exceed $50,000, and the remainder of such start-up expenditures shall be allowed as a deduction ratably over the 180-month period beginning with the month in which the active trade or business begins.

while not taking an annual salary might cause tax issues for the shareholders and S-Corp the timing of taking the salary is not specified in the code or regulations.  what not to do. some S-Corp shareholders take distributions during the year and then at year-end reclassify and report some or all as salaries. if caught by the IRS it would result in severe penalties. 

however, if you don't take distributions (including paying personal expenses)  repay shareholder loans, or take salary advances not reported as such then you could wait until December to take it.

read this thread about a court case involving no salary but shareholder/officer took distributions

https://www.hallkistler.com/s-corporation-officer-must-take-a-salary/ 

on appeal, the Tax Cort sustained the IRS. T.C. Memo 2013-180

the thing with low income on an S-Corp is that the IRS tends to concentrate audits on taxpayers with a lot of income because that's where an audit is likely to bring in the most dollars. other audits arise because something on the return seems out of whack with the expected range. 

have I come across S-Corps where no salaries were taken because of low income or losses the first couple of years with no IRS audit? yes. they were rolling the dice and won. put another way. an S-Corp with $800,000 in gross revenue and no officer's salary is more likely to be audited than a similar case where revenue is only $5,000

no officer's salary stands out because that's on line 7 of page 1 of the return. 

[Rick19744 · Accepted solution]

Some additional comments:

• Apparently the CPA you either talked to or visited did not do a good job of explaining S corporations and how they work.  You shouldn't be having to ask this question if you had a good one on one with a tax professional who provided thoughtful advice.
• The key focus of the IRS is that they look for "reasonable wages" being paid.  There is no definition for that term.  It is just based on facts and circumstances.
• I would agree that if you are just making ends meet or generating little income in the beginning, you may not need to pay yourself a wage.  
• The key to bullet 3 is that you also don't make any distributions, other than sufficient distributions to pay the tax on the S corp earnings that are passing through to you (federal and state).
• As a shareholder in an S corporation, you will receive a Schedule K-1 each year that reflects your share of the S corporation earnings and separately stated items.  Your K-1 will then be entered into TT.  The software has a good format to walk you through the input.
• Also make sure that someone maintains your tax basis in your S corporation.  This is key.
• I recommend you either have another meeting with the CPA to go into more detail so that you understand the mechanics, or if you are questioning this individual, make a switch until you feel you have a good relationship with this individual.

[PMT_2021]

Thanks for both the answers. While i understand the normal working of an s corp and distribution/wages, i really dont understand how forms work. That being said, i understand he is saying to take it all as distribution in the beginning until i make any serious wages. He said we can look at Q2 and start payroll then. So i understand now that K-1 has to do with distributions under 1120. Now as far as payroll goes, can we still run it quarterly or has to be done monthly?

[DanielV01]

@PMT_2021 Your K-1 has to do with corporate income, not necessarily distributions.  They are two different things, though many treat them as if they were the same.  Corporate income is what the business is considered to have made, which gets passed through to you via Schedule K-1, where you then report on your personal income tax return for taxation.  This corporate income is then "transferred" (for lack of a better term) to your capital account, where you can then distribute it to yourself.  Since it's the corporate income, and not the distributions themselves that are taxed on your personal return.  Your capital account serves almost like a bank account.  As long as you have enough equity (or basis), then your distributions are a tax-free return of capital.

But before you can make distributions, you must ensure to pay yourself "reasonable compensation".  Reasonable compensation basically means wages, but it can also refer to things like 401(k) deferrals, medical premiums for a 2% (or greater) S-Corp shareholder, FSA childcare deferrals, etc.  If you have employees, you will no doubt have a set schedule to pay them.  However, if you are the only employee of the S-corp, what matters is that you pay yourself "reasonable compensation" for the year.  It is not inconceivable for that compensation to be paid yearly, as long as it is "reasonable".  After reasonable compensation has (or will) be paid, then you can elect to have distributions made.

As far as to what "reasonable" compensation is, you can ask:  How much would a company pay me for the job that I am doing?  You can use the 401(k) deferrals as well as S-Corp Medical Premiums and other similar types of compensation to arrive at your final numbers to determine whether or not you are paying "reasonable compensation" or not.  And most will try to use the low-end figure for someone working at that same type of job to determine whether or not their compensation is "reasonable" or not.

[AmeliesUncle]

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@PMT_2021 wrote:

 Now as far as payroll goes, can we still run it quarterly or has to be done monthly?

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That is a matter of state law, according to the state's Department of Labor.  I can't verify the accuracy of this webpage, but it does lay it out nicely on a state-by-state basis.  It is also possible that your state's rules could have exceptions for owners like yourself, so you would need to check with your state's Department of Labor.

https://www.patriotsoftware.com/blog/payroll/pay-frequency-requirements-state-federal/

[Mike9241]

are you asking about the payroll tax returns and required tax deposits or how often you must pay your employees?

for state laws as to paying employees

https://www.patriotsoftware.com/blog/payroll/pay-frequency-requirements-state-federal/ 

however, I have seen situations with S-Corps where the sole shareholder/executive/employee did not take a payroll until near year-end. of course they were never audited by the DOL in their state.

[PMT_2021]

Hi Mike

yes, that is exactly what i was asking. I guess as others have pointed out, the IRS wont care much if you aren’t making any major amount of money and just surviving and if you do payroll or K-1. However, i think we have to file quarterly 941, so payroll once a quarter is minimum once the business starts making money. Yeah this is a one owner s corp. I guess once payroll is setup and if youre doing it yourself with qb desktop then payroll is not that tough. 
Thanks to experts like you and others in this chain i am learning a lot. 
one question i may need a separate thread on is reasonable pay and if it can be hourly for a one person S corp. I guess hourly reasonable pay is easiest to find and justify especially if i just resigned from a job and knew what i was being paid hourly

[PMT_2021]

• Thanks for the detailed response Rick

I will most likely continue my CPA search. I have spoken to 6-7 Cpa’s. The issue i see is that some of them are just throwing crazy fees at me. For example, one CPA that i liked and was ok with his annual fee of about $2500 was asking me for $700 for filing an 1120 for 2021 for no activity. The S corp would start 1/1/22 so will file 1120S in 2023. So its difficult to trust this guy if he wants to charge this much for a zero filing
This CPA i found thru a family member and told me that he doesnt need money for a zero filing 1120. But on the other hand he seems very laidback and was like call me when u start making serious money. 
I think i now have a better understanding of s corp and tax forms to fill. If i do choose to go with something like a QB desktop to do my own payroll and quarterly/annual taxes, does it walk me through all thats required for federal and state (illinois)? Also, main reason to hire a CPA is reasonable wages. Can i pay myself hourly?. I just resigned from a job and i know the hourly rate so thats what i would make in the market

[tagteam]

Compensation simply has to be "reasonable" when certain factors are considered.

See https://www.irs.gov/pub/irs-news/fs-08-25.pdf

Further, you might want to try contacting an enrolled agent (EA) in your area.

See https://taxexperts.naea.org/listing/service/corporations