Topic Thread

W2 Pay to Non-active owners

  • 1.  W2 Pay to Non-active owners

    Posted 08-10-2018 11:49
    Have a strange question for you.
    Does anybody know how the IRS might treat a situation where an owner of a corporation has a nonworking family member on W-2 payroll?
    Some background. The W-2 employee is a family member  Who is a shareholder but does not live or work where the company performs work and performs no work for the Corporation.
    My concern is that the IRS may treat this is some sort of tax avoidance game in an audit. The owner reports the W-2 payroll and also taxes are paid on that payroll, so there's no direct tax avoidance that I see. The problem is this W-2 shareholder has not lived or worked for the company for more than five years and there's no paper trail showing any work on behalf of the company.
    The owners' unstated purpose is to pay that family member as their job isn't enough to meet their needs.

    The owner Ned is in the highest tax bracket. The W-2 shareholder family member is in a lower tax bracket.

    Chris Rea CLCS
    Vp - Surety
    Six & Geving Insurance, Inc.
    Colorado Springs CO
    (719) 590-9990

  • 2.  RE: W2 Pay to Non-active owners

    Posted 08-11-2018 07:26
    Good morning.  

    This could be viewed as a position taken by the Corp to avoid higher tax bracket.  Not sure if this is a S or C.  The IRS could potentially add back the salary and consider it a dividend to the non working shareholder.  I have not seen this position taken by the IRS,  but have seen them remove bonuses taken by owners of C corp that substantially reduced corp tax.  The IRS viewed it as excessive compensation and disallowed the deduction.  




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  • 3.  RE: W2 Pay to Non-active owners

    Posted 08-11-2018 17:54

    I see two possible issues:

    1. If the company is an S corp, theoretically this could be considered a distribution as there is no work being done.  If it is considered a distribution, it could be disproportionate to ownership, which is not allowed.

    2. Overall, if it is not work, and given, depending on the relatives relationship to the person who is granting the payment, it could be considered a gift. 

    Thomas Herrington MST, CPA
    Hypower, Inc
    Ft. Lauderdale FL
    (954) 978-9300

  • 4.  RE: W2 Pay to Non-active owners

    Posted 08-13-2018 11:30
    It's a obviously a distribution because there is no work being performed, and thus not compensation. If it's a C Corp, then it's likely a dividend (depending on the accumulated E&P account) which is not deductible for the corporation. If it's an S Corp then it's a disproportionate distribution which probably busts the S election. Neither outcome is good.

    Someone suggested that it may be a gift, and I'd like to clarify that it cannot be a gift because gift tax only applies to individuals. If the money is coming from a corporation (S or C), then it's not an individual giving the money, therefore it's not a gift. A distribution from a corporation (save for minor small amounts) would be either a distribution (dividend, return of capital, depending on E&P account), or compensation.

    I used to have small business owners try these games all the time when I was at Deloitte.

    Chris Sundberg, CPA, MST
    Assistant Vice President
    Mullis Newby Hurst LP
    Addison TX
    (972) 201-0444

  • 5.  RE: W2 Pay to Non-active owners

    Posted 08-13-2018 11:25
    If you are deducting that expense on the company's tax return, you have a problem.  Based on your description, this is not an "ordinary and necessary" expense and therefore is not deductible.  Also, this could be considered a gift on behalf of the owner and may cause problems for the owner in their personal estate planning / annual gifting program.  I suggest you consider increasing the dividend or classifying this as a loan against the stock to be paid back upon future sale of the stock.

    James Burnett
    Chief Financial Officer
    W.M. Jordan Co., Inc.
    Newport News VA
    (757) 596-6341