Rookie Question About S-Corp

[misspt]

I'm pretty sure this is a dumb question, but I need to ask it to be sure. I have a S-Corp with 3 assets with loans the business is making payments on (2 vehicles and an expensive piece of equipment required to perform my job),
these payments are being "passed through" to me as income on the K-1 (not sure about this lingo, btw). Is this correct? TIA.

[Deleted]

The payments you are making to pay off the loans on the equipment are being passed to you as income? Something sounds wrong about that.

[misspt]

That's exactly what I thought, but could not get the accountant explain to me why.

[misspt]

What made me question it was the disbursements made to me and my business partner did not come close to matching the amount listed on the K-1 he produced.

[Deleted]

For the disbursements, do you know what the disbursements were? Were you paid a wage? A dividend? A distribution? All three?


What other info is on the K-1?

[misspt]

I am paid a wage and receive a W-2 for that, then I take distributions. No dividends.

[misspt]

on the K-1:

box 1: Ordinary income $XX (much greater than my calculations due to payments made on loans being included)
box 11: Section 179 deduction $XX
15A: AMT 25
16C: Items affecting shareholder basis $XX
16D: Lists the exact amount of our distributions per my calculations

Nothing else filled in.

[Deleted]

Does your CPA have a reconciliation between your business's net profit and the profit shown on box 1 of your k-1. Book net income and taxable net income are not the same, so it could be that the assets were fully written off for tax purposes in prior years, but they are being depreciated over a number of years for book purposes, so they are adding that back to your taxable net income because it was taken on a previous year.. I am just guessing, though.

[misspt]

Yes, Archie, he does have a reconciliation showing the business's net profit and box 1 and this excludes the payments made on these three loans (they weren't subtracted from the profit). The vehicles were written off fully in previous years, but are still being depreciated, but I'm still not sure I am understanding the concept??

[misspt]

Karma to you, BTW, for trying to help me understand.

[Deleted]

If I understand it correctly, this is the issue.

You actually have 2 set of books.

One set is your "normal" GAAP books. Income - expenses = net income

The other set is your tax books. Tax income - tax expenses = taxable income.


The equipment in question was purchased in previous years.
For your GAAP books: It was capitalized and depreciated for book purposes, so that you have depreciation expense every year for your GAAP books until that asset is fully depreciated.
For your Tax books: It was written off (fully expensed , fully depreciated via section 179) in the year it was purchased. This is done to reduce your taxable income as soon as possible.

So now, the year after your purchased the equipment:
For your GAAP books - you have $1000 of depreciation expense
For your Tax books - you have $0 of depreciation expense because it fully expensed in previous years.

So to get from your GAAP net income to your Taxable net income your CPA added back that depreciation that was taken on your GAAP books that you couldn't take on your taxable books.

Clear as mud?



By the way, you should be able to verify this. Look at the k-1 for the year you bought the equipment. The net income on the top should be lower than your book net income because of the the fully expenssed equipement.

[misspt]

I do understand that, I need to see if the piece of the equipment was fully depreciated in 2009 (it was purchased in Dec. 2009), b/c I don't think it was. And you are correct about the previous year's K-1 showing less than what was disbursed. And just to be sure I understand the bottom line, showing this money paid to the loans on the K-1 is correct due to the way the depreciation was handled?

[mwcpa]

the principal part of debt service is NOT a tax deduction...
when one uses debt to acquire an asset, pay for an expense the deduction is claimed on the day the debt was incurred, not when the debt was repaid (accrual).

Section 179 is an election to accelerate a deduction, it has nothing to do with cash flow....

So, I borrow 10K for a new piece of equipment on 12-1-09 (100% financing) that was placed in service on 12-2-09. I qualify and elect a section 179 deduction in 2009 for 10K. In 2010 I repay the principal. Prior to the equipment I had 100K of profit in 2009 and the same in 2010.

The "taxable" income in 2009 would be 100K before the equipment less section 179 of 10K to net to 90K
The "taxable" income in 2010 would be 100K

Assuming I had no receivables or accounts payable an no other debt on December 31, 2009 or 2010 my balance sheet would be as follows (assuming no distributions from profits to owners)

Tax based balance sheet
Cash, 1/1/09 15K
Common stock 1/1/09 11K
Retained earnings ("AAA") 4K

Cash 12/31/09 115K (15K 1-1-09 + profits in 2010 before equipment 100K)
Equipment 10K
Less accumulated depreciation (10K)
Total assets 115K

Bank debt 10K
Common stock 11K
Retained earnings 94K (4K on 1-1-09 + 100K profit before equipment - section 179 10K)
Total liabilities and equity 115K

In 2010 since you deducted the equipment under 179 in 2009 you have NO deduction in 2010 for the debt repayment, that is merely a balance sheet shifting of an asset (cash) to retire a debt.

Cash 12/31/10 205K (115K 1-1-10 + profits in 2010 before equipment 100K less repayment of bank debt 10K)
Equipment 10K
Less accumulated depreciation (10K)
Total assets 205K

Bank debt 0K (repaid in 2010)
Common stock 11K
Retained earnings 194K (94K on 1-1-10 + 100K profit no depreciation in 2010)
Total liabilities and equity 205K

[nancy65]

Oh, man! there are so many misunderstandings in this question--and the followups--that I don't know where to start. I'm glad that mwcpa jumped in first.

You seem to be expecting to see the loan payments as expenses and since they aren't, you seem to be assuming that they are income to you. As mwcpa explained in great detail, the loan payments are neither income nor expenses to anyone; they do not come into the income/expense picture at all.

You also seem to be trying to match the income on the K-1 to the distributions you received. This is not the way it works. The income per the K-1 is your share of the net income of the business. Revenue less expenses equals net income. Then divided by the number of partners equals each partner's share. Your share of the net income would be the same if you took no distributions, or more distributions, whatever.

I hope this makes sense.

Edited to add: The payment on the loans has nothing to do with method of depreciation used. They are totally different animals. Depreciation is depreciation, whether the equipment was purchased for cash on on credit.

[Deleted]

Mar 19, 2011 11:00:04 GMT -5 @nancy65 said:

Oh, man! there are so many misunderstandings in this question--and the followups--that I don't know where to start. I'm glad that mwcpa jumped in first.

Hey... I jumped in first.. And I don't think my answer was half bad. Of course I am slightly biased.

[Deleted]

Mar 19, 2011 15:36:04 GMT -5 Lady Gaga Gaga Snerd said:

I would advise you keep all your business and personal money in separate accounts and not comingle anything.

Yawn.

[nancy65]

Mar 18, 2011 10:06:12 GMT -5 misspt said:

Yes, Archie, he does have a reconciliation showing the business's net profit and box 1 and this excludes the payments made on these three loans (they weren't subtracted from the profit). The vehicles were written off fully in previous years, but are still being depreciated, but I'm still not sure I am understanding the concept??

The vehicles were written off fully in previous years, but are still being depreciated,

This statement is a contradiction of itself. Being written off means being depreciated. Or do you mean that they were fully paid for?

ArchietheDragon (may I call you Archie?): I'm sorry, I didn't really mean to imply that you weren't in there trying to help also--and yes you were First. I just meant that mwcpa was there before me. I sure could have worded that better. Your answers would have been good (IMO) if you'd been talking to someone who had a clue, but from the OP's responses, I don't think you were getting through.

[nancy65]

Mar 19, 2011 15:36:43 GMT -5 ArchietheDragon said:

Mar 19, 2011 15:36:04 GMT -5 Lady Gaga Gaga Snerd said:

I would advise you keep all your business and personal money in separate accounts and not comingle anything.

Yawn.

You can yawn all you want, but that is very good advice, and something that a LOT of small business owners don't follow. Which is one of the main reasons that I'm glad I'm retired--I don't have to deal with those messes anymore!

[TheOtherMe]

Mar 19, 2011 17:03:39 GMT -5 @nancy65 said:

You can yawn all you want, but that is very good advice, and something that a LOT of small business owners don't follow. Which is one of the main reasons that I'm glad I'm retired--I don't have to deal with those messes anymore!

One of the many reasons why I am glad I retired. Comingled accounts make an IRS auditor's work very easy if they decide it's all personal unless you show them it's business. All deposits income, all withdrawals personal.

Two accounts, especially if it is a corporation.

[commentator]

Mar 19, 2011 15:36:43 GMT -5 ArchietheDragon said:

Mar 19, 2011 15:36:04 GMT -5 Lady Gaga Gaga Snerd said:

I would advise you keep all your business and personal money in separate accounts and not comingle anything.

Yawn.

Arch, you might take the right position on a tax related post once in a while but this wasn't one of those times.

[mwcpa]

nancy... not just small, but larger ones too... does Leona Helmsley (I did not check the spelling) comes to mind... but I am sure by the definition of a small business these days her company probably was small....

this is a battle I have to address every day with many business client... the dinner "date" with the significant other is not a tax deduciton... going on vacation and checking business e-mail does not make it a business day... etc., etc...

[nancy65]

Mar 20, 2011 8:26:21 GMT -5 mwcpa said:

nancy... not just small, but larger ones too... does Leona Helmsley (I did not check the spelling) comes to mind... but I am sure by the definition of a small business these days her company probably was small....

this is a battle I have to address every day with many business client... the dinner "date" with the significant other is not a tax deduciton... going on vacation and checking business e-mail does not make it a business day... etc., etc...

lol I never had Ms Leona as a client, but had plenty of contractors and other who paid bills out of whichever account had enough money in it--kid's tuition out of the business account, business equipment purchase on the personal credit card, etc.

They always say, "well you figure it out", but then when they get the bill its all "But I didn't want to pay that much for you to figure it out."

[TheOtherMe]

Mar 20, 2011 8:26:21 GMT -5 mwcpa said:

this is a battle I have to address every day with many business client... the dinner "date" with the significant other is not a tax deduciton... going on vacation and checking business e-mail does not make it a business day... etc., etc...

Disallow, disallow, disallow! ;D

[mwcpa]

i agree theo... the problem we legit practitioners have to face is the entire cottage industry that provides the what can we get away with / audit lottery type services... we even have had those types post here claiming that they could say what they want and attack those who refuted their outlandish positions or noted that Canadian tax law was different that US tax law... but we have kind of digressed from the original posters issue...

[TheOtherMe]

Yes, we have. I've been on both sides of the tax fence--auditor and preparer. My advice to any legitimate business was always keep separate accounts--no commingling of funds. That was my advice as an IRS agent and as a tax preparer.

If the OP says he is a rookie, the advice is pertinent. I was always amazed as a preparer when people would tell me everything they did was related to their business. I left one preparer because he let one client deduct his breakfast every day on his way to work, among other things. Same restaurant, same amount Monday through Friday. He told me my job was not to audit. I told him that was true, but it was also not my job to prepare a return I absolutely knew was wrong.