Accounting Question

[Terry D EA]

This question is in relationship to my post about the S-Corp and officer employee situation. This company is using the accrual method of accounting and is using QuickBooks. The bookkeeper has created bills for rent they have not paid. They have created the expense account and have lumped everything in the accounts payable and have not made a separate "Rents Payable" account. At the end of 2012, there is 50K in the rent expense account. The account is zeroed out (closed) on 12/31. All appears to be fine so far. In my opinion, the accounts payables need to be separated out which is fairly easy to do in QB. Here is the question, if this company liquidates and doesn't pay the rent due and the rent expense of 50K was taken against the gross income for the 2012 tax return, doesn't the amount of unpaid rent have to be included in the gross income for the 2013 tax year?

Here is my take, they took an expense deduction for something they didn't and apparently will not pay and in the long run, this overstates the expenses and understates the income.

They also want to remove old (four or more years) of unpaid bills that various vendors have not been paid. Doesn't the same apply here?

[Terry D EA]

Doing a bit more diggning, I found some additional info. They have paid a reduced amount of the rent. There is an unpaid rent balance of 20K. In my opinion, the 20K is the amount to be added back to the income for the 2013 year.

[JohnH]

Is the rent paid to a related party?

If so, there are special rules to consider.

[Terry D EA]

It maybe. The officer and sole shareholder of the S-Corp is a single member/Owner of the LLC that the rent is paid to. This LLC is a disregarded entity and all income and expense pass thru to the single member which I know you know this. Does this consititue a related party? The LLC is not related to the S-corp in any other way.

[jklcpa]

So the owner of the S corp is also the owner of the facility, is that correct? Under code sec 267, only the rent actually paid is deductible. Even if the entity liable for the rent payment is using the accrual basis of accounting, because it is paid to a related party, the deduction is limited to the amount that is included in the income of the cash-basis recipient/owner. Including the unpaid rent back in income in 2013 is not the proper handling because it sounds like it should never have been deducted in the first place. If the books are accrual, then this would be a timing adjustment for expenses on the books/not deducted on this return. Likewise, it is possible to have the reverse when an accrual-basis company pays back rents due, and in that case the rent deduction on the return will be higher than the accrual based GAAP financial statements.

As to your other question about separating out the rent payable from the trade a/p, yes, I would definitely do that. Especially in the case of rents payable to a related party where many months of rent go unpaid, it is important to track this separately from a/p and other accrued expenses.

As for the other trade a/p, I don't know that I'd be so quick to write that off. Those should have been legitimate costs of producing the product that are payable to outside vendors that still have a claim against the assets of the company as unsecured creditors.

[JohnH]

Thanks for filling in the details Judy.

Don't know why I thought to ask the "related party" question.

Maybe it derives from the habit of listening to what isn't being said...?

[Terry D EA]

Yes the owner of both entities are the same. So it sounds like the return needs amending. Thanks Judy