Karen,
You are supposed to post your questions on the forum at clientwh...@gogglegroups.com. That way everyone gets the benefit of the question and answers plus you benefit from the experience and knowledge of 100s of forum. I did run this through our AI and got this response…..
When an S corporation shareholder takes a draw from the corporation, it's typically accounted for as a distribution of the corporation's earnings and profits. Unlike a salary or wage, which is paid for services rendered and subject to employment taxes (Social Security and Medicare taxes), a draw is not considered compensation for services and therefore is not subject to these taxes. However, the distinction between a draw and a salary is crucial for tax compliance, especially regarding the requirement for reasonable compensation for S corporation shareholders who actively work in the business.
Here's how the process generally works:
1. Accounting for the Draw: On the corporation's books, the draw is recorded as a reduction in the shareholder's equity account. It decreases the retained earnings of the corporation, reflecting the payout of profits to the shareholder.
2. Tax Return Reporting: For tax purposes, the draw is reported on the shareholder's K-1 form, which shows their share of the corporation's income, deductions, credits, etc. The amount of the draw is included in the shareholder's income but is not subject to self-employment taxes. It's important to note that while the draw itself is not taxed as salary, the IRS requires that shareholders who provide substantial services to the corporation receive reasonable compensation, which should be paid as wages subject to employment taxes.
If a shareholder did not take a reasonable salary for their services to the S corporation, the IRS might reclassify some or all of the distributions (draws) as wages. This reclassification can lead to several tax consequences:
· Employment Taxes: The IRS can assess Social Security and Medicare taxes on the reclassified wages, and both the corporation and the shareholder could be responsible for their respective portions of these taxes.
· Penalties and Interest: The corporation and shareholder might also face penalties and interest for failing to report wages properly and for not paying the appropriate amount of employment taxes.
· Impact on Deductions: The reclassification of draws as wages could affect the corporation's deductions for compensation expenses and the shareholder's eligibility for certain tax deductions, such as the Qualified Business Income (QBI) deduction under Section 199A, which has specific rules regarding wages paid by the S corporation.
To avoid these issues, it's crucial for S corporation shareholders who are actively involved in the business to ensure they receive reasonable compensation for their services, reported as wages. What constitutes "reasonable compensation" can vary, but it generally involves considering factors such as the shareholder's roles and responsibilities, the time and effort devoted to the business, and compensation levels for comparable positions in similar businesses.
Lee
On May 1, 2024, at 8:09 PM, Karen Fuller <kare...@gmail.com> wrote:have a client that took 10000 owners draw but no compensation. There are not reserved for a draw.Would the 10,000 be treated as self employment income on her personal return?
Lee Reams Sr., BSME, EA Chief Content Officer CountingWorks Pro | CountingWorks | TaxBuzz | TaxCPE p: 1.800.442.2477 x240 w: www.countingworkspro.com/ e: lee....@countingworks.com ![]()
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Lee Reams Sr., BSME, EA Chief Content Officer CountingWorks Pro | CountingWorks | TaxBuzz | TaxCPE p: 1.800.442.2477 x240 w: www.countingworkspro.com/ e: lee....@countingworks.com ![]()
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