No earned income - refundable Child Tax Credit

[buelfarm]

A friend with an LLC set up as an S-Corp asked me to do her taxes, last minute.  She is HOH with a young daughter & expected EIC & CTC refunds, as in the past.  She obviously did NOT understand that the distributions from the S-Corp (her only income all year) from Line 1 $5,960. are ordinary income and do not qualify her for EIC.  Strange thing is, the refundable CTC ($1,500) is not being calculated in the tax program.  What in the world am I doing wrong ... is there some little check-box I am missing? PLS HELP! 

[qbteachmt]

Could you please clarify this: "She obviously did NOT understand that the distributions from the S-Corp (her only income all year) from Line 1 $5,960. are ordinary income"

Are you referring to Line 1 of the 1040? And a W2?

Because distributions are not a taxable event, unless they exceed basis. However, payroll (a W2) would be taxable for anyone, as this is their earned income. The other money from the success of the S Corp would be part of the pass through reporting via K-1.

[abctax55]

If you follow the F 8812, page 2, I believe you'll find your answer.

Earned income is needed.

[buelfarm]

Line 1 of the Sch K-1 from the S-Corp is ordinary income.  My concern is not the EIC, as she obviously has no earned income as a result of choosing this particular tax vehicle ( LLC as an S-Corp ) - it is the CTC b/c the instructions are clear that you do NOT need earned income or income at all in order to receive the fully refundable portion of the CTC ($1,500).   How in the world do we do that?! 

[dkh]

Did you prepare the SCorp return ? 

Why isn't there a W2 from the SCorp ?

[buelfarm]

I see the earned income requirement there, and the instructions seem clear, as well.  This taxpayer pulled up an IRS.gov page when she stopped in to show me that she could qualify for the refundable CTC with no income ==> turns out, she may have put in 2022 & her search engine assumed the 2022 filing season (which were 2021 returns) when she would have been right.  Not this filing season, it seems.  

[buelfarm]

No, I did not - she simply brought me the Sch K-1 (along with a long story ... ) - she has NO IDEA how the numbers they gave the accountant came out on her Line 1, Sch K-1.   He treated everything as Distributions, apparently, even though the 2 partners each had Draws ... I told her I thought there should be Form W-2's ... maybe I was right about that?  Feeling like I should never have told her I could look it over for her, even though I don't "do" S-Corps ... I thought I couldn't go wrong with a correct Sch K-1, but she had no answer when I inquired about the Form W-2.  

[Just-Lisa-Now-]

theyre not partners, theyre shareholders, if youre not up to the challenge of preparing the SCorp return (no judgement here, I turn away SCorp returns as well), she may wish to seek out a more qualified S-Corp preparer next season to get her on the right track.

[abctax55]

b/c the instructions are clear that you do NOT need earned income or income at all in order to receive the fully refundable portion of the CTC ($1,500). 

Really ?  I think not.  Rules change from year to year.

[buelfarm]

Thanks, Lisa ==> think you didn't read where I said that I did NOT do the S-Corp b/c I don't do them ... she just wanted me to help her out on her personal return & did not like my answers 😞 

[buelfarm]

Exactly right !  You'll notice that my later reply referenced her pulling up 2022 filing season results from IRS.gov ( which were 2021 tax returns ) rather than the current season ... my harried mistake to not double check myself, for sure ! 

[qbteachmt]

"there should be Form W-2's ... maybe I was right about that?"

Yes, you are.

"as she obviously has no earned income as a result of choosing this particular tax vehicle ( LLC as an S-Corp )"

One S Corp requirement is Reasonable Wage to those who are doing the work of that business of that S Corp.

"He treated everything as Distributions, apparently, even though the 2 partners each had Draws"

There is no such thing as Draw, or Distribution, or Guaranteed payments. That distribution and these draws, should the IRS realize there is no wage reporting, has the right to recharacterize any takings as Taxable wages, resulting in late fees, penalties, employer taxes and past due reporting, etc.

Your friend needs professional help right away, because she is already not in compliance. And needs a new CPA/accountant, as well.

If you work for an S Corp, you are supposed to be paid as wages. Period. That is earned income from the work you are doing. You might also be a shareholder-partner but you are an employee, too. There also are some rules and limitations on >2% shareholder, >10% shareholder, and other financial management considerations. All of which start from the employment position of this person, as "doing the business" for the corporation, which cannot do its own work.

[BobKamman]

Well, no, there is such a thing as distributions from an S Corp, otherwise IRS wouldn't use that word on the return three times (Schedule K, lines 16d and 17c; and Schedule M-2, line 7). But an S Corp can have distributions, with no profit; and a profit, with no distributions.  Even if there are no distributions, the shareholders must pay tax on the profit, so each case is different based on facts and circumstances.  I wouldn't have a problem preparing a return for an S Corp owner/employee with a K-1 showing $50K of ordinary business income, if those funds were kept in the business to pay off debt or buy more assets.  

[qbteachmt]

"But an S Corp can have distributions, with no profit; and a profit, with no distributions."

You are overlooking that the issue at hand is No Earned Income. Which would be the error.

"I wouldn't have a problem preparing a return for an S Corp owner/employee with a K-1 showing $50K of ordinary business income, if those funds were kept in the business to pay off debt or buy more assets."

There is no earned income for a person who was not paid through payroll. They didn't participate in the concept of S Corp. There are all sorts of wrong here, and the preparer has expressed confusion and is right in their understanding that things have gone wrong.

You are not helping, Bob.

[BobKamman]

It is not helping to start expounding on S Corp taxation with someone who does not prepare S Corp returns -- then to deflect when you have posted misstatements.  

I should have made it clear -- "I wouldn't have a problem preparing a return for an S Corp owner/employee with a K-1 showing $50K of ordinary business income, if those funds were kept in the business to pay off debt or buy more assets -- even if that person received no W-2 wages."

[qbteachmt]

That's why it's called "Tax Practice."