S-corp SH-employee

[Margaret CPA in OH]

I have 2 small contractors who have really been hurt by the economic situation. They are each sole shareholders in their respective S-corps. One is going without pay and can do so because his father is helping financially. The other, however, has filed for unemployment benefits (I just found out) for himself and his son/employee while continuing to work. They just aren't bringing in enough money to keep up with the materials payments and also pay wages. (Of course, he has been generating losses for a couple of years.) Anyway, another contractor friend told him he files for unemployment every December to pay off his bills but continues to work. Apparently the state says it is acceptable (on hold for more details) but what about federal stuff? Does the unemployment income just go on his regular tax return? Any impact on the corporation? It's a 2010 issue for me but thought I would get a head start if anyone else has experienced this. Thanks!

[imjulier]

Margaret-

I have been through this in CO with a couple of contractors. CO allows s corp SH to collect unemployment as long as the s corp has been paying in to unemployment. Some states allow the SH to opt out of unemployment and if they choose that route, then no unemployment coverage when needed. Colorado does not interpret that a s corp SH may still be employed by the s corp even though there is no work. My thought is that the s corp may still be able to pay some wages to the SH even though there is no work. In fat times, save money and pay less in wages for those lean times when you have to do business development. However, CO doesn't see it this way so the s corp SH can collect unemployment. I don't fight it nor tell my s corp SH to collect or not collect unemployment since that is the state's decision.

While I haven't collected unemployment in over 25 years, when I did, I was required to file reports with the unemployment office showing how many employers I had contacted and if I had earned anything in the period I was filing the report for (earnings reduced unemployment benefits). Clearly, this leaves room for anyone to report any information they want unless they get audited by the department of labor and employment. I believe reporting this accurately is an ethical decision that we all have to make. I suspect your clients are not reporting this accurately if its required at all. As a CPA, I don't think this impacts me at all unless I've told my client to do that....which I would never do. So, if they choose to collect unemployment and file the paperwork however they see fit, that is their decision.

Unemployment income would just be reported on the federal and state returns of the individual as this is how its being received and how it will be reported on 1099G. Impact on the corporation is that their unemployment rate may go up and require them to pay more in unemployment taxes in the future....but probably not more than the benfit so I'm sure the SH won't worry about this.

Julie

[Margaret CPA in OH]

Thanks so much, Julie! I will follow up with the state office to see what they require/expect and advise the client. I won't audit what he does but do want to be informed correctly as to what should be done. Perhaps I might actually advise the other contractor, too, if in his benefit. Thanks again!

[JohnH]

Keep in mind that even if it's legal & acceptable in your state, the client needs to know there can be a stiff price to pay in the coming years. Even a small claim can wipe out the account balance (or reserve) and cause the rate he pays on future employees' earnings to skyrocket. I've seen employers go form a .25% rate to 5,6, or 7% rates for several years following a single claim. The effect on large employers isn't as dramatic, but for a small employer it can come back to bite them as a very expensive surprise. Not saying he shouldn't do it, but he needs to know it isn't free money.