Quick IRS audit question

I know that several people on the forum have tax knowledge and I have very little. So I'd like to learn from your greatness.

IRS has audited us and did the usual disallow all deductions thing. They may have us on one item, but I'm not sure. In my mind it only changes WHERE we do the deductions for expenses, not IF we can take the deductions.

Before we spend money on an accountant I'm trying to see if I can understand this so I'm entering data into TurboTax to see what it has to say about certain things & numbers mostly to help me truly understand the situation and this way I can play with it to see the ramifications. I need to understand this before I begin talking to a real person in earnest.

In 2009 we changed from a C Corp to an S Corp as that was required by new legislation so that we could pay ourselves. We needed to have Schedule K disbursements instead of commission income to meet new laws in our industry.

My wife filed us as self employed, but IRS says that we can't be self employed (even tho we own the company), & that we now have to be employees WITH A SALARY. Which means no more Schedule C to write off costs.

So who gets the expense write off? What number is reduced by the amount of the costs?

TurboTax hasn't asked me about S Corp or C Corp, it's just said self employed or not. Which will obviously lead me down the wrong path if I tell it the wrong thing.

I hate being dumb about anything so I'm trying to educate myself before I go out and do something stupid. Which means I'll probably be playing with this for days.

Mentally I'm hung up on this whole employee vs. self employed thing. The IRS site is no help.

It seems to me that if we are now employees that my first step is to redo taxes on the Corp, but then we go back to who gets the expenses and how. The way the auditor did it seems to make us lose business expenses.

unless you want to get berkeleyed in the arse, go to an accountant.

Our family business was nailed with a "Personal Property Audit" last year on Farm Assets.......only farms in our particular county were hit with it, which was odd. We hired an accountant and subsequently a lawer due the auditor claiming we owed over $25k in taxes, despite our paperwork, deductions, and accountant double checking all our work saying otherwise.

The Auditor was mistaken in using the list new price of what our machinery cost then versus what it is worth via the depriciation schedule

Sorry I can't be of more help, but yeah, hire a GOOD accountant; someone who comes highly recommended. Let him or her deal with it. As often as I've got the goddamned IRS up my ass, it's worth EVERY_PENNY!

BEFORE I go to an accountant I want to understand some basic principles.

I've been screwed by incompetent accountants/CPAs more than any other field.

They want to do what they know or what's easiest for them rather than do what's best for me, hence why I want to have a basic understanding first.

I'm definitely getting one involved if only for their ability to be able to argue with the auditors.

I am not an accountant but have layperson experience doing what you describe. So take this as an attempt at helpful advice, but you should probably involve an accountant at some point, even if just to get a final yes/no answer.

Sadly with a corporation, I believe you do need to have a salary from it and not just use schedule K pass-through income. The deductions for business expenses would be taken by the corporation, not by you personally. The corp would then pay you after expenses, withholding taxes on the amounts paid to you, then file W-2s to you.

I have to do this for our company and it's a bit of a chore but it's gotta be done if you go with a corporate structure and get money from the company.

That assumes you actually take money out of the company to pay personal expenses. If you don't take money out, you may be able to defer all that, but it sounds like you do.

Addendum: the corporation takes the business expense deductions on form 1120S. You have been filing 1120S, right? :-)

My wife is an accountant.

David S. Wallens wrote: My wife is an accountant.

And she says........................

When I started my S corp some 10+ years ago, I used a trusted accountant to take care of all that tax stuff. I just handed him a balance sheet at the end of the year & all was good. Absolute genius - no audits or even any questions (although he'd represent me in the case of an audit). One less thing to worry about & I could focus on growing the business.

KJ

We got audited because we changed from the C Corp to an S, or at least that's what the auditor said.

Kendall that's the way we used to do it.

But remember in an earlier post where I said I'd been screwed by accountants/CPAs more than any other professions? It cost me a LOT of money doing it that way.

I'm a lot more hands on now.

carguy123 wrote: In 2009 we changed from a C Corp to an S Corp as that was required by new legislation so that we could pay ourselves.

Read here and then find other internet advice, or just find a tax attorney:

http://www.bizfilings.com/learn/s-corporation-vs-c-corporation.aspx

Get your hands off. Quickly.

Accountants are not out to get you. You need to get one who understands your needs.

You're questions are completely jumbled up, and you are going to get into trouble. Turbo Tax isn't asking you about a C Corp vs S Corp, because you are trying to file a 1040. That's a personal tax form- has nothing to do with business. Also, you most certainly can pay yourself through BOTH a C Corp and an S Corp, but one is a salary or wage paid from the corporation to an individual, and the other is a transfer (since an S Corp is a pass through corporation, it is technically the same entity as you personally. A C Corp is a different entity)

You can't file your corporate business taxes through your personal tax return. It's 2 different filings, with totally different forms.

My concern is that your posts don't even seem to recognize the completely separate entities that exist between your corporation and your personal life. This will end badly.

Get an accountant.

I'm a CPA and I agree with ^^^. Feel free to shoot me an email with more specific questions.

carguy123 wrote: In 2009 we changed from a C Corp to an S Corp... wife filed us as self employed, but IRS says that we can't be self employed (even tho we own the company), & that we now have to be employees WITH A SALARY. Which means no more Schedule C to write off costs. So who gets the expense write off? What number is reduced by the amount of the costs? TurboTax hasn't asked me about S Corp or C Corp, it's just said self employed or not. Which will obviously lead me down the wrong path if I tell it the wrong thing.

That's right, if you incorporate a business, the corporation gets the writeoffs, not you. For you to get the write offs personally, the business has to be a sole proprietership or partnership. Incorporating the business made it its own legal entity, and the writeoffs go to this legal entity, not to you.

It is a major change, and one the IRS likes to pursue because people frequently make the mistake of trying to handle a corporation like a sole proprietership.

Turbotax doesn't do well with small corporations, or farms for that matter.

You would do quite well to talk to a CPA of tax specialist who handles small corporations. This is a hostile audit by the IRS. Not really any different than facing criminal charges in court. In neither case should you attempt to defend yourself, alone, without legal aid and counsel.

OK let me back up. An accountant got me into this mess and yes TurboTax does well on small businesses, as a matter of fact it's done better than any accountant we've ever had. All I'm trying to do now is understand a few basics so that I can be sure a new accountant doesn't mess me up even more.

And yes I totally understand the difference between the corporate taxes and own personal taxes. It's how the 2 money streams have changed with the S corp that I want to understand better.

We've been self employed since 1974. We always used an accountant/CPA to do our taxes and then TurboTax came along. For 3 years we used an accountant and then double checked their numbers with TT only to find the accountant missed some basic things. We'd go back to the accountant ask about the other deductions, find out the accountant missed it, they'd modify the taxes and we'd file. We changed preparers 3 times because of mistakes that TT found. After 3 years we began to do it ourselves.

We did it ourselves until some industry law changes made the transition to an S Corp desirable.

We had about 3/4 of a year as C Corp and 1/4 as S corp. Not knowing the ramifications we took our taxes to an accountant. She filed the money flow the same for both corps -well except my income went thru a Schedule K. And because of our history with accountants we had someone else do it the next year and they did it the same way so we went back to TT.

Enter IRS.

They looked at 2 years. One year with accountant (who's phone is disconnected) and one where my wife filed it - the same way the accountant did it.

By every definition we can find we are self employed. Even the IRS auditor called us self employed, but the IRS findings say we are employees and are trying to disallow all our business expenses. I'm just trying to understand the write off (or is it cash flow?) differences between the 2 different types of entities.

And yes we filed the 1120S.

So we have expenses that in years past we'd have taken off our personal taxes. IRS "seems" to indicate that those same expenses would now be taken out of the company side of the equation which would reduce our compensation and taxes. Of course when IRS worked their findings to see how much more money we owed them, they just threw away all the expenses. Go figure.

One of my mental issues is that we paid those expenses out of our personal account not the company account. Paying out of the company account would not have been practical for most of the expenses so how do we write them off on the company side?

I've spent hours and hours on the IRS site and I cannot find any place they address this. I am going to look through http://www.bizfilings.com/learn/s-corporation-vs-c-corporation.aspx Maybe it will answer my questions.

As I said in my first post, at this stage I'm trying to understand things better so that I'm sure I get it done right this time. I've found TT to be like Excel. I can play games on it and see the ramifications which will help me going forward.

I don't think accountants are out to get me, but everyone I've used so far has screwed up royally hence why I want to understand it better. I've found I can't trust them, I can only trust myself. They will do only what they understand or what is easiest for them.

And as I've stated multiple times, once I understand it then I will be finding one to help with the IRS. If nothing else they can respond to any questions or shenanigans in real time where I'd have to go back and do more research.

carguy123 wrote: One of my mental issues is that we paid those expenses out of our personal account not the company account. Paying out of the company account would not have been practical for most of the expenses so how do we write them off on the company side?

What one normally does in an employee-ish position is paying the "impractical" expenses out of the employee's pocket, then put in an expense report to the company, which then reimburses you. That's how my current employer (small-ish business) does it and that's how I did it in two other countries where I was running my own businesses.

The other option is to get a debit or credit card for the business and use that for the expenses. I don't like the terms on small business credit cards so I'd most likely try to get some sort of debit card.

What I can see and know, the IRS is saying employee as in, you work somewhere, which isn't a lie. Self employed means that if something happens to you, the company folds, IE- not even your wife/spouse/biz partner can run it in your absence. So is that the case? Someone at the IRS has a hardon to disallow anything resembling working for yourself, as you can almost be totally transparent between biz and personal expenses.

I would think to write off what you paid out of personal money, you, as the company, would have to write the check back to yourself and have a contract "note" stating everything and that it would be paid at some point. Basically, take it as a loan or lease, but I think at this point of the game, you can't backdate yourself into that position.

Just my couple of pennies for the cause.

I've done articles of incorporations in the past. Don't have any active corporations at this time. While business law is part of my background, I am not a corporate lawyer or a tax law expert by any means.

I think it's very foolish to use internet forum advise when tangling with the IRS. You're also asking the IRS to help you.. Recognize that they are prosecuting you. If you were up on criminal charges, would you go to the prosecuting attorney to seek help in your defense?

That said.

A C corporation makes a $100 profit this year. It pays taxes on that $100. It then distributes the profits in accordance with its articles of incorporation and the shareholder percentages. The shareholders then pay income taxes on the portion of that profit that they receive. IE, double taxing of that $100; first at corporate rates and then at personal rates.

An S corporation makes a $100 profit this year. It passes that profit through to the shareholders. Those share holders declare their portion of the profit on their own personal taxes, and pay taxes on it. IE, single taxing, at personal rates.

A sole proprietorship makes a $100 profit this year. The proprietor declares it on their personal taxes, and pays taxes on it. IE, single taxing, at personal rates.

A different example.

A corporation buys a circular saw. Doesn't matter the type (S or C). The corporation owns the saw. It is a corporate asset. If a shareholder uses this saw, the shareholder must pay taxes on the benefit they receive by using the saw.

A sole proprietorship buys a circular saw. The individual owns that saw. They can do with it as they wish. If they wish to write off the expense of the saw, it must only be to the % they use it for work.

Foxtrapper I'm not going to rely upon internet advise, I'm trying to understand some concepts.

I think that the part I've been having so much trouble understanding stems mostly due to the employee status. After talking to people it appears that the accountant did the corporate taxes right, except for the expenses portion.

BUT, and that's a big butt, they both counted my personal income as 1099 except for the Schedule K part. Since 2 different accountants did it that way and since it was familiar I was taken aback when IRS said you can't do that.

Several people have talked about using an expense account reimbursement method which makes sense IF I'm an employee (there's that issue again).

I deal with self employed people all the time when they want a mortgage and how we have to handle it is totally opposite of what IRS just told me so that really added to the confusion.

But then again it shouldn't surprise me as I had to tell the IRS auditor the new rules because they hadn't heard them yet. They kept telling me to operate in a manner that was inconsistent with the new laws and would have cost me my license and some jail time.

Technically, you are "self-employed" but are an employee of the corporation. Clear as mud? ;-)

dculberson wrote: Technically, you are "self-employed" but are an employee of the corporation. Clear as mud? ;-)

Yeah, but they've never called me that in the past or allowed me to call myself that in the past.

Also with they way I have to treat people in a mortgage who are self employed, no matter what you call yourself you are still self employed. Your salary doesn't exist, just let me see your tax returns please.

It is anything but surprising to find the individual IRS auditor is not thoroughly versed on the complexities of the law for your particular case.

I don't really understand what you mean by counting your personal income as 1099. Are you saying the corporation(s) paid you via a 1099, instead of having you declare passthrough profit/loss via an 1120? If so, I can see why an auditor would be saying you're an employee of the corporation, and that your personal and corporate books are not right.

Expense reimbursement makes a lot of sense for corporations, including for share holders. Keeps the separation of assets clear. Vehicle miles are a good and common example. You personally own the car, and let the corporation pay for its use of your car. Do it in accordance to the IRS schedule, and they usually don't flag it. Get creative ($200 per mile), and they will.

The rules for self employed are completely different from the corporate rules. Don't go looking to the self employed (sole proprietorships or partnerships) as a reference for how to handle a corporation. That will get you burned, eventually.

I think you are way over due in getting a competent CPA involved. You are getting conflicting advice here, and it sounds like you are not focusing on the real issue.

I will tell you as a CPA for almost 20 years, working for national firms for 15 years and now running the tax department of a major corporation, that S Corp income is NEVER self-employment income. At the bottom of Page 19 of the 1120-S instructions it specifically says:

"Unlike most partnership income, S corporation income is not self-employment income and is not subject to self-employment tax."

If you have an S-Corp for which you perform services, you MUST pay yourself like you would any other employee, including filing payroll tax forms 941, 940, W2/W3 and any state employment tax forms.

I think you are worrying too much about the deduction disallowance and too little about the whole self-employment/payroll issue. Get a good CPA and let them sort it all out.

No SEADave it's almost time to get a professional involved. First I needed to understand the situation so I'd know how to proceed.

I had a couple of basic issues that weren't computing based upon the fact I'd had professional help and that's how they did it. So I wanted to be sure that I wouldn't jump back into trouble, but instead made sure I got out of trouble.

I can't remember ever hiring a competent CPA or any tax preparer and not losing on the proposition, therefore I want to know enough to make sure I get someone good. I'm sure they are out there but unless I have knowledge I can't tell a good one from a bad one until too late.

Go to school. Become "competent CPA." Profit?