corporate shield and personal income tax "problem" ?

Edwards Finance > Loans

Q. In 1999 I did some consulting as a sole proprietor (ie, Sched C under my own SSN). I paid some quarterlies but not enough as I underestimated the total value of the consulting. The consulting reached into 2000 (was open ended contract) but came to a sudden close in March of 2000. I did not find another gig for a few months and the one I found never amounted to much as the project I was supposed to work on was in limbo and then got cancelled as the company it was for got bought. I was actually on contract under a 1099 to another company that was contracted with a consultant group who was helping this company with the project. But the end result was that for 2000, after the initial work that had continued from 1999 into 2000 ended, there was about $30 or $35k gross earned for the limbo-contract with a few months of no work and about the same, a little more in the initial 3 months. Due to self-employment etc the tax bill for 2000 was over $20k. August of 2000 I got married and when I got back from my honeymoon it became evident that that contract had died more or less and about $14k was taken in gross from August through December 2000 and the contract officially ended at the end of the year and after that I was unemployed though I looked long and hard for new contracts as well as FT work. I never found any -- still have not though the past few years I have been devoting to another business or two I started in the mid 90s. For 1999 I had prepaid some but not enough. When that became evident, I was going to pay it and the small penalty from money I had saved for my final payment and then from ongoing revenue, and then adjust my quarterlies to avoid the problem in 2000. The unexpected loss of the work in March 2000 and then the lack of new work for a few months and then the work that never took off and got going and kind of sputtered along and died, and then the lack of new work for years as it turned out, meant that my tax savings ended up being used for rent, food, car payments, etc. as did the ongoing new income from the contract that never really got off the ground. My wife is from Japan and was not allowed to work until she got permanent residency. She had been a student and had had permission to work as a student up to around $3k-$4k worth, which she did and paid taxes on. (Before we got married). She finally got temporary work permission at the very end of 00 or 01 while the INS worked on her application and in 2001 got a job as a waitress. This is the money we lived on in 2001 until she was able to get licensed as a nurse and get a nursing job towards the end. Then we lived off her beginning nursing salary. Anyway, I was unable to make up the missing 1999 taxes due to lack of work and using the saved money and the meager incoming to cover rent, food, etc. I also did not pay any for 2000 for the same reason. So now I owe for 1999 and 2000. (1999 is just the difference from what I had paid in quarterlies and the end tax and 2000 is for it all except the money my wife had earned before we married). We foolishly filed a joint return in 2000. 1999 is my name alone. 2000 is both of us. So now, even though most of the money was earned before we got married etc, they naturally are trying to collect from her as well. She has filed for innocent spouse relief since the bulk of the money was earned before she married to me and she is from Japan and did not understand things about the US tax system etc. It is my mistake to file jointly but as a new married, I wanted the tax break that came with that and fully expected to get new work to be able to catch up and get on with life. That is all background. The issue is thus: In 1995 I started an S-Corp in my name. It of course has its own EIN etc. It sells product on the internet and was a side-job I did (started as full time but I started FT employment in 96 so the business became part time in middle of 96 and stayed that way until mid 2001). After not finding any work despite head hunters looking, my own efforts, etc (looked for PT, FT, and contract work), I decided to make my part time Corp a full time job and try and build the business so I could eventually get an income from it to support my family. Prior to 2001 it had been a $10k-$15k a year gross business and some years had taxes to pay, which we paid, and some years had a small loss. But we were trying to get it to be a sustained profitable business. Since then it has grown to over $200k gross in 2004 (this year is down 10%) and has reported profits since 2001. (1999 and 2000 it reported a loss so it contibuted no income to my 1999 and 2000 woes). It has paid taxes through our own personal returns since 2001. (We have of course been filing and paying 100% of taxes since our woes of 1999 and 2000 -- both my wifes PT nursing job and our business profits). The profits themselves have been reinvested in the corp so we have never had any cash of our own but did count the profits, naturally, on our taxes. If we had been taking the profits, the business would not have been able to grow. We also have a small LLC from 1997 that is still small and provides internet services to clients with servers it maintains. In 1999 and 2000 it had losses but since mid-2001, when I decided to make a full-time effort in my own businesses, I have worked to grow it and it has been profitable the last 2 years (03 and 04) I believe. Maybe 02 too. I forget. Its profits were duly reported and taxes paid. It provided no income to the 1999 and 2000 problem years. It is slowly growing and I have been reinvesting all profits back into the business and have been able to double or triple its gross in teh last 4 years due to these investments. So, to recap, after it became clear in mid 2001 that I was not going to find more work (tech recession and dot-com bomb made sure of that), I went to work fulltime on my two business and have grown them, but not to the point that they support me and my family and I am trying to continue to grow them. For our 1999 and 2000 tax problems, we have been trying since 2001 to settle with the IRS. I filed an OIC in 2001 but never got an answer until Jan 2004. They seem to have lost it and we moved [and duly reported our new address] in 02 to be near family and live with family since my wife was pregnant and our landlord wanted to sell the house we were renting. We hired a tax law firm to help us in 2004 and they dilly dallied around and finally in October 04 (we contacted them in Jan 04), after I complained to AMEX [we had paid them a flat rate package deal using 2 AMEX cards], they got around to producing an OIC for us which was almost identical to the one I had submitted in 2001. We submitted it but the IRS came back and said we needed to submit a second one since only my name was on the 1999 bill but both of our names were on the 2000 bill. So they, the tax firm, produced two new ones which when added together equaled the original and we sent them in. Long story short, the IRS sent some worksheets to us in June saying they were going to recommend denial. I asked the tax firm to respond. They did not. Then the OIC was denied and I spoke with the tax firm and we agreed to do an appeal (our flat rate package included up to 3 appeals in the price). We left town to visit my mother in law in Japan about 10 days after the OIC was denied (thanks to some Free Tickets from a frequent flyer program) and this firm was supposedly working on an appeal. We returned a day before the appeal needed to be filed and they missed that deadline too. Now I am trying to work with AMEX to get my money back since this firm did not uphold their end of the bargain. Anyway, I had sent in requests for info in June about the warning of denial as I did not understand where they were getting their claims of collectable income. We live paycheck to paycheck and make up the difference with credit cards (and have amassed in the last few years a large CC balance due to that). We have two old vehicles, a small IRA, and a utility trailer as assets. No real estate or anything. We had offered the full value of the IRA as the trailer, at the original time of offer, was mostly owned by the bank. It has since been paid off. I finally, last week, got the offer manager to explain where all this collectable money was coming from on the worksheets (he only did it verbally and refused to provide it in written form even when asked both in writing and verbally). The IRS is claiming all business income for the next 5 years (minus cash expenses but not things like depreciation) plus all assets [without taking into account the high debt and payables of the businesses] of the S-Corp and LLC, even though they have no beefs with the IRS. They have paid their taxes and filed as they should and even I as the owner am not allowed to raid the businesses that way. We naturally included Schedule E income from the businesses, even though we don't actually get any of that in our hands due to trying to grow the businesses to a sustainable level) on our income statement. That is not the issue. The issue is the busines income above and beyond that and the business assets. I claimed to the IRS that they only had claims to the business profits of the S-Corp and LLC and perhaps any assets of them both if I were forced to liquidate them by the IRS -- they would first have to cover any of their own creditors and payables and debts first before I would see any "profit" from asset sales. But the IRS claims they have first dibs to the income and assets of these two businesses. These businesses are separate legal entities, have paid their taxes and filed their returns, are on the up and up with the IRS. They contributed no income to the problem yars of 1999 and 2000 so there is no residual tax problem. Why can the IRS pierce the corporate shield/LLC shield due to the stock owners/share owner personal tax problems? ...

A. What do you mean when you say the S-corp and the LLC "have paid their taxes"? S-corps and LLCs *don't* pay taxes. They are pass-through entities. Yes, returns get filed for them, but those are just informational returns for shareholders and the IRS. *All* of their profit flows through to shareholders' personal returns and *must* be reported on those personal returns one way or the other (through a combination of reasonable wages and dividends). It sounds like you are confused as to how S-corps and LLCs are taxed (or, rather, are not taxed) and how they interact with shareholders' personal returns. And keep in mind that if you are in a position where the IRS has the power to attach your assets, and your assets are, among other things, shares in S-corps/LLCs, the IRS can attach those shares, become the owner of those shares, and then as the owner, seek to liquidate the entities to bring in cash to pay the tax debt. -Unfortunately, you've got the shield concept backwards. Having the LLC and te S Corporation could possibly protect you from a liability of the LLC or the S Corporation. Because you are a 100% owner, the LLC and the S Corporation have no protection at all against your liabilities. You control them: you decide whether the businesses make distributions and you have the ability to liquidate them. (Think about it--if your approach worked, everyone would just run up huge debts, transfer all their asssets to controlled corporations, and then tell the creditors that they were out of luck). The S Corporation shares and the LLC interest are just assets on your balance sheet as far as the IRS is concerned. Really not very different from holding shares in IBM. IBM is a separate company, too, but you'd still be expected to liquidate your holdings there if you had to pay a tax liability. It sounds like the IRS is actually giving you a deal. They let you continue to own and operate the two businesses, and you agree to turn over income from the businesses until your tax liability is settled. The IRS could have demanded that you transfer the ownership to the IRS to help pay your taxes. If you've been reinvesting all the profits back into the businesses, is there any way either of the businesses could qualify for a loan? If so, you might be able to distribute the loan proceeds to yourself, pay off the IRS to get them off your back, and then work hard to get the bank loans paid back. Given your current problems with the IRS, it could be difficult to get a loan approved, however.

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