Didn't issue payroll for your S Corp? Here's what to do. | Reasonable Compensation Workaround

in this video I'm going to discuss what to do if your business is taxed as an S corporation and for whatever reason you as the owner of the S corporation didn't pay yourself reasonable compensation so to provide some more context I'm saying here the previous tax year is over it's now 2023 and you didn't run any payroll for yourself in 2022 what do we do in this scenario how can we avoid issues with the IRS so if you continue watching you can expect me to cover a few things so one thing I'll cover is your three options if you didn't issue payroll to yourself and for the third option in particular which is the option I recommend I'm going to actually show you how to execute this strategy by sharing my screen and showing you the tax forms and how to complete them I'll also answer the question of do you need to pay reasonable compensation if you didn't take any distributions that's a common question that I get and also one more question that I get frequently is do you need to issue payroll if your business if your business rather wasn't profitable so I'm going to answer or all of that so if you you know want to get the answer to those questions please continue watching before I jump into that content though if it is your first time watching my name is Navi Mirage and I'm a CPA that teaches entrepreneurs how to save thousands of dollars in taxes I do that here on social media but I also teach it in even more comprehensive and easy to understand way through a course that I developed you can find those details on my website which is navimarodcpa.com but for now if you get value out of this video If you learned something consider subscribing to the channel or perhaps liking it sharing it with a fellow entrepreneur who might have this question as well or maybe even your tax preparer all right so uh let's let's do this real quick before we Dive Right In to answering those questions that I brought up a moment ago let me just give you a little a bit of a foundational information or knowledge I think it's always important to provide the context of sort of how did we get here okay so if you have a business that is taxed as an S corporation you are required to pay yourself what's called reasonable compensation that's an IRS term okay and you're supposed to pay yourself reasonable compensation if you the business owner are performing or performing rather substantial services to the business the way you pay yourself that reasonable compensation should be by registering excuse me registering with the fed and also with the state and informing them that hey my business has an employee in this case I'm saying the employee is you the employee sort of shareholder and as a result you need to file payroll reports and pay payroll taxes now when you're doing this uh payroll properly there's a lot actually happening that you may not realize if you're a new business owner so I'm just gonna Maybe cover some of those so you can get some context as to why this is even a big deal and why the IRS and why the state even wants you to do this all right so at the federal level uh if you're running payroll prop properly you are filing quarterly tax forms with the IRS called 941s form 941 okay you're also sending in uh Social Security uh Medicare and federal income taxes payment uh federal income tax payments to the IRS each quarter you're also filing an annual form it's called form 940 to file your federal unemployment taxes you're making uh a payment for your federal unemployment taxes as well and that's just at the federal level at the state level you're doing similar things so you're filing quarterly payroll reports informing the state of how much payroll you ran and uh you're making payments to fund your State's unemployment insurance you're reporting state income taxes withheld from your paycheck and making payments each quarter uh to your State's Department of Revenue okay there are also a lot of states where you are funding other programs when you're running payroll such as family medical leave and there's you know bunch of different programs out there based on what state that you reside in and your your business operates in all right so that was a little bit of context right so when you're not paying yourself properly or not paying yourself at all and taking out all the money from your S corporation as distributions you're avoiding all of those items I just mentioned and that is when the IRS and state will sort of come after you okay and you could be in this situation for a few reasons right maybe you didn't even know running payroll was a requirement of yours um you might be in this situation because you just executed what's called a late S Corp election or maybe you were just getting bad advice from a tax preparer or a tick tocker or someone else on YouTube right um uh and by the way if you've never heard of that whole late s corporate uh S Corp election you can elect to have your LLC or Corporation taxed as an S corporation late uh for example you can file the form in 2023 to cover 2022. this is kind of a misconception out there where you need to do that at the beginning of the year or within 75 days I created a video on it uh it's also on my YouTube channel on social media so check that out if you want to learn more about that topic and I'll link it at the end of this video for you all right so okay with sort of that foundational stuff out of the way let's kind of dive into what I said we were going to cover at the top of the video so what are your options if you didn't run payroll properly for the prior year okay option one is you could just you know gamble roll the dice uh don't pay yourself and don't even try to pay yourself right that's what I'm saying here I do not recommend that you go this route there's fees involved if you're caught uh interest penalties uh from not only the IRS the FED right but also um the state so I I wouldn't do that those fees add up rather quickly especially if you're caught doing this for multiple years all right and it's it's so easy I'll show you in a moment um by sharing my screen how easy it is for the IRS to see that you've been doing this incorrectly just by simply looking at your tax return okay so option one just take the gamble roll the dice I don't recommend it option two is you can kind of issue yourself a late payroll event um this is how this kind of used to work many years ago let me explain it for you okay let's say it's January of 2023 and you're you're realizing now you should have run payroll in 2022 and you didn't okay well what you could do is jump through a bunch of Hoops and try to issue payroll manually what I when I say manual what I mean by that is not to have a payroll company assist you because they likely won't right the time has passed they they can't go back in time right so what you would do here is you would literally complete all those various federal and state tax forms I just mentioned a moment ago and send in those payments um so and you kind of have to do that on your own and for most new business owners this will turn into a complete disaster because you'll end up receiving a bunch of notices in the mail from both the fed and the state that you did this late and therefore you're going to get assessed the late filing fees the late payment fees and the interest penalties and what have you um it's probably better than option one but uh you know I I think option three here is is the best okay so what's option three option three involves issuing a 1099 specifically uh for the current year uh that's a 1099 NEC to yourself so your S corporation is going to issue a 1099 NEC to yourself the employee shareholder the owner of the S corporation all right now please I want you to understand this is going to be a one-time thing you're not going to do this year after year to pay yourself the reasonable compensation okay if you do that you um sorry if you sort of execute this um you know issuing yourself the 1099 you're going to want to set up proper payroll immediately in the following year so this is sort of like a quick fix hey we don't have a time machine we can't go back in time and fix it this is my best alternative that I could come up with but going forward you know Mr IRS agent or you know state agent um I've I've I'm set up on on payroll properly uh with the fed and state and I'm doing this properly going forward okay um so let me share my screen with you now and start showing you some of this so here's how it works okay right now I'm showing you a 2020 1120s this is the tax return for an S corporation okay so let's say in 2022 your S corporation earned a hundred thousand dollars in profit and by profit I'm saying here that uh you actually earned or had 125 000 worth of Revenue or sales right and you had 25 000 worth of expenses and you landed at a hundred thousand dollars in profit let's also assume with that hundred dollars of profit that you distributed the entire one hundred thousand dollars uh to yourself um so let's let's look at the tax return so we got 125 000 of Revenue or you know it's officially called on the form gross receipts or sales um here was that 25 000 expense this is just an example guys I'm just showing you hey I'm just saying hey you just had the only expense you had was 25 000 worth of advertising all right so your total deductions were 25 Grand and so that left you with profit online 21. it's called Ordinary business income of a hundred thousand dollars now what I would not do is is do what I'm going to show you here in a second which is to take all one hundred thousand dollars of that out of the company as a distribution okay I'm gonna scroll down uh there's a few pages normally these Pages would have information on them but I'm going to scroll all the way down to page five and look at this schedule this call this schedule is uh schedule M2 and we can see here we're going to pay attention to this accumulated adjustments account so um you know probably you know a whole other video would have to be created just to discuss this but basically what do we have here I'm saying this is a brand new business okay and so that's why the balance at the beginning of the year in this it's kind of referred to as a AAA account um is zero the ordinary income from page one line 21 that's the hundred thousand dollars of profit I refer to is going to show up here now occasionally and again I won't go into it now there might be other editions other subtractions or whatever and you're going to Total those up and come up with your number so here uh we're saying we didn't have any so we just had a hundred thousand dollars when we added all these lines together but the distribution here is a hundred grand so your S corporation earned 100 Grand in profit and you're saying hey IRS look at me I took a hundred thousand dollars right out of the business I did not issue myself any payroll because going up above again I know I'm scrolling quickly is on line seven the line that says compensation of officers is completely blank right there's a zero all right um and I'll also I'll throw this out there and I'll scroll back down real quick going back to schedule M2 I think this is important for you to know as a business owner um even if you hire you know someone to prepare your taxes you want to keep your eye on this okay I see some tax preparers trying to be slick with this and not complete schedule M2 because I believe if you read the instructions for this there are certain scenarios where you're not required to complete it um and this would leave the IRS in the dark as it relates to did you take distributions or not you know they can't tell if if you don't have the number here right and in my opinion like I said this is a good way to determine if your tax preparer knows what they're doing is by looking at this schedule to see if it's accurate based on what you know about your business right so what I'm saying here is if you look at this and you're like well wait a second I didn't take a hundred thousand dollars out or if it says zero here and you're like wait a second I took like 50 60 grand out of my account um in terms of distributions why did my tax preparer put a zero on this line seven of schedule M2 okay food for thought something to think about uh definitely ask the question of your tax preparer okay all right so um let's talk about what do we do to sort of uh fix this right you know we don't want to prepare the tax return in this way well I think your first step would be to determine what reasonable competition is for yourself all right and I'm just going to pick an arbitrary number um of uh forty thousand dollars right let's say you determine it to be forty thousand dollars and some of you are freaking out right now because I said forty thousand dollars but try not to focus on the dollar amount I'm saying is that is reasonable compensation maybe in the future I'll do a video about reasonable compensation if that's something you want to see you want to understand what reasonable competition is how much you should be paying yourself things like that you know leave me a comment let me know that's the content you're looking for and I'll cover it um but what you're going to do is you're gonna have your S corporation issue you you the individual a 1099 is called a 1099 NEC I'll pull it up here on the screen um in the amount of 40 Grand in this situation right because if you determined that was reasonable compensation for you now if you know your stuff you might be saying yourself okay but Navi there's a deadline to file uh a 1099 NEC right you're right and likely you've missed it you've missed that deadline but just issue the 1099 NEC anyway the worst case is you'll pay you know a late filing fee for the 1099 if uh the IRS decides to enforce that on you okay so you can kind of see here on the screen it's it's simple it's your S corporation is going to be the payer right so your s Corps business name and address will go here you'll put your s Corps Ein your uh individual your individual social security number your name your address and the Forty thousand dollars right so we're saying the S corporation issued the individual 40 Grand thousand forty thousand dollars as a payment okay this forty thousand dollars is then going to get reported on your individual tax return on a schedule C and I have an example of that too because I wanted to show you the forms and sort of how you would do this okay um the 40 000 the 40 000 is going to go and get reported on a schedule C like I said it's part of your individual tax return your individual tax return is called form 1040 that's why that's written here okay um but if you do this I want to caution you I'll show you what it looks like here in a second but I want to caution you if you do this make sure that you're not receiving What's called the section 199 a deduction for the Forty thousand dollars a profit that's going to end up getting generated here on the schedule C that might be a little bit over your head but section 199a that's also referred to as qualified business income deduction or qbi or qbid you want to make sure you sort of zero that out so that you don't get a deduction for that because you shouldn't be okay so um like I said you want to eliminate that so if you look here um I just have that you know your individual name would be the name of the Proprietor in this example this is the 40 Grand that's coming over to you via sort of that 1099 NEC and you're not going to have any expenses in here okay everything here is going to be zero to make sure that on line 31 your net profit ends up being the Forty thousand dollar that you see here okay now I'm not sure if you could even do this on Turbo Tax for yourself okay you might need to use um some sort of professional tax prep software or if you're doing this manually you could do it uh manually right but generally speaking I wouldn't be preparing my own S corporation tax return anyway uh if I was a business owner I would recommend getting some professional help to do this because uh you know as you probably learned by watching my videos there's a whole bunch of stuff that you're learning with each video that you watch that you didn't know about if you try to do this stuff on your own okay now let's look at what your 1120s tax return looks like now if you kind of do this I don't really want to call it a strategy but this workaround okay so let's go to the first page this may look like it's the same 1120s but it's a little bit different it's the same in a few ways right I'm saying you still had 125 000 in sales that didn't change but what I'm saying here is on line seven you're gonna put in that forty thousand dollars was paid at paid as competition of officers okay where's this 40 Grand coming from this is the 40 000 that you issued the 1099 for okay which is also going to end up on your schedule C right it's that same forty thousand dollars you also had that twenty five thousand dollars in advertising expense right that didn't go away you still incurred that expense and so your total deductions when you add the 40 then the 25 is 65 000 okay and so um your ordinary business income your profit at this point is sixty thousand dollars now your business really made a hundred right it's just that you paid 40 000 of it via payroll would be the proper way to say it but via the 1099 and then sort of work around that we're doing okay um so let me show you what the schedule M2 looks like on page five so if we scroll down here this looks a little bit different than what you saw a moment ago so now we're saying our ordinary income was sixty thousand dollars again we're saying we didn't have any additions or reductions to this this account this AAA account and when we combine lines one through five we're getting that 60 Grand and in this scenario I'm saying hey we did take out sixty thousand dollars we did take out all of the business oh sorry all of the profit we distributed that profit To Us by transferring the money from your business checking you know to your personal account we did take that distribution so this is sort of what the schedule M2 should look like if you're if you're going about this now if you didn't if you didn't take this distribution right then don't put it there right if you took a much less a lesser distribution then you wouldn't put sixty thousand dollars there okay so let's cover a couple more things um are there risks to doing this yes yeah there are some risks to doing this this is a workaround it's not the proper way but it's better than doing nothing it's better than option one which was rolling the the uh dice right gambling if you will at the end of the day the IRS may see what you were trying to do here right and ease up on you um you did the majority of the proper sort of tax payments not really we'll come to that in a second but the majority of the Social Security was paid uh the Medicare taxes were paid sort of by doing it this way but remember what you did not do is you didn't file payroll reports throughout the year like you were supposed to you didn't pay federal unemployment taxes you didn't file the state unemployment taxes all that stuff all those same things I mentioned earlier um you didn't do and you didn't do it at the state level either right and you know in some cases it's actually the state that is the one that will sort of come after you for this and then the state uh you know working with the IRS is going to get them involved and now you've got to deal with the state and both the IRS okay so um I know I may have lost some of you when going through this you know this video and this topic I should say this video probably makes sense if you're a tax preparer it's probably crystal clear but if you're a business owner and you're watching this and some of this is kind of a bit much that's okay I would expect that to be the case you might need to watch this particular time video uh one or or two more times to have it fully sort of sink in for you okay um so you know what I just showed you again is a workaround on how to handle this in my course I I alluded to it earlier in my course I don't teach you the wrong way I don't teach you how to do things like this right I teach you how to do it the correct way so you're not fumbling with all these workarounds for things that you should have done properly and you're not scrambling to try to figure this out last minute if you visit my website navimurajcpa.com this is what you'll see there's a lot of free resources here so other videos you can file an escort for free you can do some other things here but if you click here you'll go to the course page and here you can learn about what I'm teaching in the course I teach all the Tax Strategies how to use QuickBooks Online a little bit of Basics about taxes and accounting how to implement all the strategies properly using QuickBooks you're going to learn everything not just the strategy but the implementation of the strategy okay and you can scroll down and see what you'll learn there's a bunch of stuff written here there's a video that goes over the course all these different lessons are here if you click here you'll actually see there's even more lessons all right so have a look at that if you want um let me now answer those other questions that I said I was going to answer for you right so one of those questions was do you need to pay a reasonable compensation if you didn't take distributions right if you didn't take any distributions out of your S corporation for the year in question then don't worry about it actually you're only required to pay yourself reasonable compensation if you take distributions out of your S corporation but here's a little Nuance with this okay you should make up for the reasonable compensation in the year you do take distributions so let's say if you make a hundred thousand dollars a year and you don't take any distributions and you do that for you know for four years right and four years so four years goes by and you take a four or you want to take a four hundred thousand dollar distribution well what you need to do instead is you need to take more reasonable compensation than you would have taken in years one two three and four you almost let's say your reasonable cop number was 40 Grand you most need to take 160 000 worth when you're taking out that 400 Grand so you take a hundred and sixty thousand dollars out as payroll and the remainder you can kind of take as a distribution because there's sort of a look back period that that the IRS views when you take that distribution all right the other question I was going to um tackle for you was do you need to issue payroll if your business wasn't even profitable okay if your business wasn't profitable in general I wouldn't worry about paying yourself reasonable compensation again there's a Nuance to this let's say you contributed a large amount of capital you would you put in a lot of a lot of cash um into the business and then you took that Capital out of the business you might be on the hook for paying yourself reasonable compensation even if you didn't earn any profit in the business that's because there's a situation where if you didn't treat that contribution of money to your company properly meaning you didn't treat it uh as a a loan to your S corporation then you might have issues when you pull that out the IRS might view that as instead of the loan being paid back to you they might view that as a distribution and you're going to be on the hook for paying yourself you know reasonable compensation even though your business didn't even make any money that year all right so um that's all I got for you on this topic I know it was sort of a heavy one um if you're watching on YouTube I'll link the video on how to make a late S Corp election and also another video I recommend watching based on the fact that you watch this one all right don't forget to you know leave me a comment like this video subscribe and I'll see you either in the course or in the next video

Channel: Navi Maraj, CPA

Views: 54,068

Keywords: 1099, reasonable compensation, late s corp election, payroll, s corporation, reasonable salary

Id: MoubkgwbTWQ

Length: 23min 39sec (1419 seconds)

Published: Thu Jan 19 2023