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Converting past S Corp wages to dividends. Opinions needed if IRS will allow?

(Disclaimer: I know I tried to do too much by myself with too little information. If I am just stuck I understand that is the price I pay for not getting more advice.) Back in 2002 a friend and I incorporated a small programming/computer consulting business and filed the S corp election in Texas. As we would make money we would simply write ourselves checks from the corporate bank account, splitting income

50/50. On a quarterly basis we were required to report payments made to employees to the Texas Workforce Commission, which we did and reported all the money we had distributed to ourselves. We did this lacking knowledge of the difference between wages and distributions/dividends. In filing the '03 and '04 941 forms we reported the amounts we had reported to TWC and in doing so generated tax liabilities for SS, FICA withholding. Never at any time did we tell an employee (myself and my partner were the only employees the company ever had) that we had withheld anything and when W-2's were generated the amounts shown for the various amounts withheld were zero so we ended up paying these taxes ourselves on our 1040's. I have verified with TWC that they will let me go back and decrease the amounts reported as wages to them as the monies given to the two owners were handled as dividends, not salaries. I am then hoping to file a correction with the IRS to get the wages reclassified as dividends. I realize that this will require me and my partner to file revised 1040's for '03 and '04. As tax was paid by us on the monies distributed the only "loss" the IRS would be looking at would be the 6.2% employer matching SS taxes and the amount for the two tax years would be around $1000. I recognize that doing this will essentially require me to refile almost every form for 2003 and 2004 as this impacts W-2s, W-3s, 1099-DIVs, K-1's, 1120S, 940 and 941 plus our personal 1040's. What I don't know is if I will be allowed to by the IRS to do it. Any opinions or experiences?

Thanks for your unofficial advice.

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Reply to
es330td
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The IRS requires "adequate compensation" for your work to be paid in wages. Otherwise, most S-corps would do what you are attempting. Profit over and above that can be in the form of distributions.

Reply to
Brew1

Thanks for your response.

I had heard this before and I knew this. I hadn't intended to zero out the W-2 wages, just reduce them so that 100% of the monies earned aren't reported as salary vs. distributions. The question I have is whether anyone thinks the IRS will reject it if I file correction documents showing the modified amounts.

Reply to
es330td

From the sounds of it, you and you're partner have managed to screw things up pretty good. The best advice I can give you is too let a professional handle it, call a CPA and let him get this done for you, or you could be looking at even more headaches

Reply to
Mark Wiley

out of curiosity, how much in federal tax savings do you expect to achieve?

Reply to
Gil Faver

es330td wrote:

First, S corporations do not pay dividends. You and your co-owner are taxed on all of your distributive shares of income from the corporation, regardless of whether it was distributed to you. I presume you understand that part, and intended to say that you paid tax on your distributive shares of income, not on the "monies distributed." If all of the corporation's gross income arose from personal services performed by you and your co-owner, it is appropriate for all, or virtually all, of the excess of gross income over expenses to be paid to the two of you as salary, subject to FICA, etc. On the other hand, if part of the corporation's earnings arise from other sources, such as the use of equipment owned by the corporation or the services of other employees, then it would be appropriate for that proportion of your distributive shares not to be treated as salary. Another way to analyze the issue is to consider what you would have to pay an employee with your skills to perform the services you perform for the corporation, or what you would expect as compensation if you were to perform the same services as an employee for an unrelated entity. In other words, since this appears to be primarily a personal service business, it is not likely that there is a lot to get back. You certainly can file amended documentation and amended individual income tax returns. However, the IRS may disallow or reduce your claims for refund based on its estimate of a reasonable salary for the services you performed for the corporation. There is no way you can, or should, get back 100% of the employment taxes you paid. In the future you should agree on a reasonable salary for your services and report it that way. You should be able to avoid employment taxes on some of your distributive shares of income -- but not on all of it. Katie in San Diego

Reply to
Katie

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