S Corporation Draw

Today TaxMama hears from VP in California who tells us. “I am VP of an S Corp. I do not draw a salary, but the president does. Does the dollar amount of owner’s draw affect taxes in any way?”

Dear VP,

I guess I am confused. There’s no such thing as an owner’s draw in an S corp. It’s either wages or dividends. Worst case, money drawn can be consulting fees. But that’s not the best idea.

If the company has enough money to pay the president enough to live on, the president should be on payroll. You will be attracting an audit and taxes, penalty and interest if you don’t establish a payroll – and fast.

As an officer, a Vice President, you are responsible for the company being properly administered – even if you don’t get paid. If IRS conducts an audit and determines that there should have been payroll, and all the related payroll taxes, YOU can be held personally liable for paying those taxes if the company doesn’t pay them. Incidentally, if IRS audits and determines this is payroll, you’ll owe all the same kinds of bucks to California, too. This is not a smart arrangement.

Right now, BEFORE the tax return is prepared, you need to recharacterize the money the president has taken as a draw. It should properly be payroll – you still have time to file a 4th quarter payroll tax return to fix this problem.

If not, it should be outside services – which means the president will have to personally pay both sides of the Social Security/Medicare taxes – total 15.3%, instead of the company paying their half when she’s on payroll.

It could be a loan – in which case you need a legal document spelling it out as a loan, with an interest rate, and repayment terms. And it must be repaid.

This is the kind of thing that really, really should have been worked out when you two started the company – not the following year, when it’s time to file tax returns.

Basically, you really need to have a tax professional come in and look at what you gals did with the books and clean them up before the S Corp tax returns need to be filed in March.

And remember, you can find answers to all kinds of questions about S Corporations and other tax issues, free. Where? Where else? At TaxMama.com

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