While working with client on YETP I discovered roughly $750K in distributions to a shareholder-employee that client agreed should really be classified as compensation based on facts and circumstances behind the payments. My plan was/is to have client declare a bonus before year-end issue a net zero paycheck so that all distributions are properly included in employee's W-2.
Client uses a PEO for all payroll and benefits processing. PEO is not a fan of this idea and won't process the bonus because they are the technical employer of record and feel the distributions should have been counted as comp when they were made and now they'll be subject to late deposit penatlies, blah blah blah.
Just looking for suggestions on how next to proceed. Determining proper allocation between wages and distributions of S Corp shareholders is not an uncommon issue - I've just never had to deal with a 3rd party payroll processor at the same time. Any input is appreciated - Merry Christmas!
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the distributions should have been counted as comp when they were made and now they'll be subject to late deposit penatlies, blah blah blah.
That is correct. You are saying it is wages. You can't pick-and-choose when to add wages to payroll forms. Wages go on the payroll forms for the quarter that they were paid.
I agree with the Happy Guy. Amending F.941's for the respective quarters would be the way to go since these were clearly payments that had already been made but were just misclassified. Your client can't avoid penalties simply by zeroing out those "distributions" and reporting a make-believe bonus with net zero payment at year-end.
If no payments were made at all during the year and your client is declaring and paying an actual bonus to true-up what should be reasonable compensation, that would be a different story.
Still an AllStar
"Determining proper allocation between wages and distributions of S Corp shareholders is not an uncommon issue"
What you have not told us is if there also was reasonable compensation all year. If there is already reasonable payroll, then the Bonus concept should be fine. The date the funds were given might be treated as lending, and the bonus check is treated as, "We changed our mind, and will forgive the loan."
But, if the taking is routine, such as when someone takes both payroll and distribution at the same time, and the distribution is routine and ongoing, that is a bit harder to justify as "lending." It looks a lot more like attempting to avoid payroll treatment.
"Level Up" is a gaming function, not a real life function.
Thank you all for your responses, especially on Christmas Eve! Of course the situation is more complicated than I initially posted; shame on me for trying to short-cut it. Scenario is actually very close to what qbteachmt is implying. Yes, compensation is already paid to employee. In the eyes of the shareholder-employee these payments represent "advances" to be taken against future bonuses payable for services rendered and/or future distributions from company profits. Miraculously they have even documented the general idea of this in writing, complete with a mention of stated interest rates. In theory the bonus payable is reduced by prior advances or the shareholder repays the loan. However, since no bonus was declared and no repayments have been made, I advised that upon examination the IRS could easily argue these advances were disguised compensation. Hence my suggestion to declare a bonus to recognize some compensation. Loan forgiveness gets us to the same place too. Company will definitely have employee make a payment for accrued interest in good faith.
Apologies if previously just calling these advances mislabeled distributions caused any confusion. If that were the case I agree on amending prior quarterly reports to capture the comp in the correct quarter; however since the PEO files as the employer of record for all of the companies it manages, I don't even think that would be a viable option (they certainly didn't offer to do so). So, assuming the above fact pattern establishes that compensation has not yet truly occurred and company is therefore not late on payroll filings, how to you proceed when the PEO responsible for processing payroll isn't on board?
In a perfect world every single one of our clients proactively calls us before trying to get creative. In a more perfect world those clients even listen when you tell them to explain potential pitfalls and consequences! Merry Christmas.
"how to you proceed when the PEO responsible for processing payroll isn't on board?"
It's a case of TMI. It's none of their judgement if you pay the CEO $60,000 (which needs to be the "going rate" within the qualification of "Reasonable Compensation") and then, at year end, there is declared a distributable bonus of another $60,000 (because the person took this other $60,000 as "advance"). That would be the addition to the final paycheck. The issue is that there also needs to be indication of Employee Loan Repayment on that paycheck, which again, I don't see why the PEO has the right to enforce that you cannot do it that way. Or, let that employee get the "take home" and then turn it over to the company the same as a real loan advance and repayment would be done.
A compensation plan can include advances against commissions, for instance, such as sales (large equipment, appliances or furniture). A sales person might get a base rate or salary + commission that is not settled until quarterly or seasonally. In the meantime, the sales person takes a draw or advance against commission. The PEO doesn't set nor enforce your compensation program. They are your service provider and you are their customer; they are not supervising you.
Let's look at the other perspective: when the Sole Proprietor asks to be paid through payroll with withholding, and the service provider does not prevent this. The responsible party for policy is not the PEO.
"Level Up" is a gaming function, not a real life function.