There is a near certainty that we can make the S Corp election retroactive to January 1 of 2018. As mentioned earlier, one of the pillars of S Corps is to pay a salary to the shareholders. If you are reading this after Thanksgiving dinner and yet another Cowboys loss, it is time to step on the gas and get payroll setup so a payroll event can be ran before the end of the year.
But if it’s 2019, and 2018 is all over, there are three options (in descending order of elegance)-
Issue a 1099 to Yourself
The amount of the 1099-MISC is entered into Line 7 of Form 1120S as Officer Compensation. Therefore from an Officer Compensation to net business / K-1 income comparison, this technique still satisfies the reasonable salary sniff.
While the IRS might frown upon this option, at the end of the day they are typically satisfied since employment taxes are essentially being paid. Again, this is not as elegant as the W-2 option, but it certainly works for the first year.
Additionally, if you were to lose an IRS challenge on reasonable salary determination the IRS would impute income on Schedule C. We are simply following what they would eventually do anyway. Again, this is a first-year mulligan. A one and done. Payroll must be set up for the following year, and normal W-2 and other filings must be done.
Reclassify Distributions as Wages
We list this option is case you or someone else wants to run a late payroll event after December 31, but we advise against it. If you want to see a flurry of IRS and state notices, and waste time wading through it all, then go for it.
Roll the Dice
What could happen? The IRS could simply impute wages, create payroll liabilities and send you a bill. We’ve seen S Corporations get these types of notices. This is not ideal since the state is not getting its share of things such as unemployment and disability, and the IRS is sharing data with states.
Again, rolling the dice is not our professional advice, even if it rhymes. We do not want some stray bullet from the IRS hitting us while trying to hit you- we will decline the engagement if you want to roll the dice. We don’t want your problems to become our problems (sorry).
Conversely, let us do it right. You sleep well at night. More rhymes. Everyone wins.
Of course the Watson CPA Group can take care of all this paperwork for you!
Huge Emphasis: We cannot stress enough that having an LLC in place is cheap insurance even if you don’t ever elect to be an S Corp. While IRS guidance is hazy, it is our recommendation plus the recommendations of tax attorneys and other consultants that the effective date of the S Corp election should not occur before the earliest date that the LLC has members, acquires assets or begins conducting business.
Taxpayer's Comprehensive Guide to LLCs and S Corps : 2019 Edition