Income Taxes for a Bonus

What do you think the answer is? What research have you done so far, and where are you stuck?

You guys are cruel.........but that's why I like you.

I see "bonus" and think it's running through payroll.

Anyone see it differently?

I'm not an accountant but from what know since taxes have already been paid, the bonus check should not be taxed again in 2008. I'm looking for confirmation from the experts.

I realize the way I asked the question does sound a bit like homework. I was trying to be as clear as possible.

Thanks for the replies.

Raffi

wrote

If it is indeed paid out as a bonus - meaning through payroll in my mind - then it is taxed as income through the owner's W-2. But, the corporation takes a corresponding expense deduction for the wages paid. The income tax effect is moot in this year, but there will be payroll taxes of some amount if it's paid out in that manner.

The term "bonus" to me, means through payroll. I like the term "distribution of profits" for "S" corp distributions not run through payroll. This phrase distinguishes those distributions from "dividends", which carry a distinct meaning of their own.

Nope, it looks like payroll, and sounds like payroll to me.Withthout any other information to indicate otherwise withold using supplemental rates.

Payroll accounting always uses CASH ACCOUNTING, so there are no (payroll) taxes previously paid on the "bonus." The taxes in the prior years paid were CORPORATE income taxes, with NO deduction for wages/bonus paid, so I don't see why he's not liable for PERSONAL income tax on the amount (with the corporation taking a deduction in 2008 for the amount paid). S-corp status doesn't make a difference here, nor is there an indication that Bob is a shareholder.

Now, even if the corporation accrued the bonus in prior years (and deducted it for income tax purposes), that has no bearing on the payroll taxes nor the personal income tax (and withholding of) that needs to be taken when actually paid and reported on a form W-2. All that means is that the corporation already has taken its deduction for wages/bonus paid and doesn't get to take that again.

Thanks for the reply. So if I understand this correctly, if the owner takes the $210K out as "distribution of profits" it doesn't go through payroll and no additional income taxes are paid.

Thanks, Raffi

According to OP, this is an S-corporation that is "owned by Bob."

Stu

I missed that part (or forgot about it). However, that doesn't affect the answer as it's a bonus, not a dividend or other withdrawl of capital or profits. All that means is that the "corporate" tax rate that got imposed in prior years used the personal tax rate schedule due to the S-election.

Bob still has to pay (personally) federal and state income tax on the entire amount of the bonus. The corporation gets a deduction for wages paid. That will cause a flow-through offseting deduction for income taxes but NOT for payroll taxes.

Exactly my thought, Dick, having taught college income tax once upon a time. So my question would be: what textbook is being used, and on what page is the question?

ChEAr$, Harlan Lunsford, EA n LA

WEll sure, if he's got that much basis in the corporation.

ChEAr$, Harlan Lunsford, EA n LA

Wouldn't he have to, since it's the remainder of the $300,000 the company earned that had tax paid on it?

Seth

But there's one other consideration. The IRS requires you to take a fair market salary and pay social security + medicare tax on it along with personal federal and state tax, and optionally take the remainder as a distribution subject only to personal federal and state tax, and if you're in California then also a 1.5% corporate tax. If you have a good year and have 210K in distributions left after your salary of say

60K, you can decide to take the the 210K in a future year. However say in the future year we're in a recession in your company only makes 20K but you take the 210K retained earnings as a distributions. Would the IRS try to reclassify 40K of that 210K as a normal salary, subject to social security plus medicare? I guess you could take the 210K as a distribution of profits from a prior year, but not sure if they let you do that.

In any case, why have any retained earnings in an S Corp in the first place?

Most compaines need working capital to remain viable and grow. Distributing all the profits may be a poor business practice.

Thanks for the reply. Going forward, Bob will not leave any retained earnings in the company. He will be taking all the profits out at the end of the year, while taking enough of it out as salary to maintain a good balance between the two.

To sum things up, Bob should be able to take the $210K as distributions during 2008 (assuming he has earned a fair amount through payroll as well), and not have to pay additional federal or state income taxes (as well as miscellaneous payroll taxes such as social security) since the $210K was already taxed in 2006 and 2007, and since it is not going through payroll. The $210K can be taken out anytime during 2008.

Feel free to comment if any of the above is not accurate.

Thanks for all the replies. Raffi

Although that is an option, it's not reflective of the original question - where as a "bonus", it was already decided to be taken in full as a wage.

Good point. But if this is a single shareholder S corp, then does it matter?

Also, if in the year you take the distributions from a prior year, if the salaries in the year you take the distributions are not so high because of a bad year, then do those prior year distributions become subject to social security + medicare taxes? I would hope not.

It depends on the type of business and future goals of management.

Distributions are not subject to employment taxes.

Raffi,

This is true, but the operative term is "he has earned a fair amount through payroll as well." You never said whether Bob had received reasonable compensation for his services to the corporation in 2006 and 2007, or whether he is being paid a salary in 2008.

The bottom line here is that once an S corporation begins distributing income to its stockholder(s), those distributions must be characterized as wages unless the corporation has already paid reasonable compensation to them for their services. In other words, if (as appears from your example) Bob received no salary or wages from the corporation in 2006 and 2007, you can't avoid paying him reasonable compensation for the services he provided in those years by deferring the distribution of those years' earnings until 2008.

The IRS is out doing aggressive audits of S corporations looking to recharacterize distributions as wages. What constitutes reasonable compensation for services depends on a number of factors, but unless Bob has already received reasonable compensation, at least some part of this distribution must be treated as wages subject to payroll taxes.

Also, you should be aware that the distribution, regardless of when in

2008 it is paid, will come first from the corporation's 2008 earnings.

Katie in San Diego