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Posted by Harlan Lunsford on January 24, 2007, 2:15 am
Please log in for more thread options L K Williams wrote:
>> I am the owner of a S Corp business started in 2005. The
>> business has not generated enough sales to pay myself a
>> salary. The 2006 income was less than $1,000. Considering
>> that I still have personal living expenses, what I have done
>> is draw cash against the paid-in capital as needed for
>> personal expenses. I have also done the reverse whenever the
>> business needs additional cash. However, on a YoY ('05 and
>> '06) basis, the paid-in capital went down by the amount of
>> cash drawn from the business in 2006.
>>
>> I don't know what IRS reaction would be if they see a
>> decrease in YoY paid-in capital but I prefer to resolve any
>> potential audit pitfall before I file my 1120S. That is the
>> reason I have come to you experts with the following
>> questions. Your response would help me consider my options.
>>
>> 1. Can I restate the drawings as loans from the business
>> instead of reduction of paid-in capital?
>>
>> 2. Can it be treated as distribution? Is there a thing like
>> tax-free distribution?
>>
>> 3. Do I owe payroll taxes on the entire drawings or on a portion of it?
>>
>> 4. What would you do if you are in my shoes :-D?
>>
>> I appreciate any help or insight that can be provided.
> You don't say what state you are in and that could make a
> difference. In most states, AFAIK, it is illegal for a
> corporation to distribute funds from paid in capital. When
> you filed your incorporation papers, etc. you specified how
> much capital had been paid in. This information is to
> protect the public from being defrauded by undercapitalized
> businesses defaulting on its financial obligations.
>
> What you probably should do is treat all the draws as loans
> and charge interest on the outstanding balance (if material,
> anyway.)
>
> Unless you are talking about very large sums of money, I
> doubt the IRS will be concerned if you don't pay yourself a
> salary. In an S-corp environment a salary would be taxable
> to you and deductible by the corporation. If this creates a
> loss, that loss offsets the salary income on your personal
> return.
>
> However, this may not be a neutral series of transactions.
> First, of course, the corporation would have to pay the FICA
> and other payroll taxes, thus increasing the corporate loss
> passing through to you. In addition, the salary could give
> rise to other benefists, such as earned income credit, on
> your personal return.
>
> If you were my client, I would probably say to reclassify
> all the drawings as loans, to document this with a written
> agreement or note, and to charge interest on the loan.
Concur with my learned expatriate colleague living the good
life over there. Or at least I hope so what with the recent
coupe.
Anyway, state laws usually follow the uniform corporation
codes laws, and it IS illegal to diminish paid in capital.
The loan route would be reasonable, but for the OP, you
might want to seek some local qualified tax help from either
an EA or a CPA. (Note to CPA's; I try to alternate
placement of our designations in every other post. This
time it's Ea's turn. (grin))
ChEAr$,
Harlan Lunsford, EA n LA
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