Expert: Vanessa D. Powell, CPA - 12/18/2009

Question
QUESTION: I work for a small LLC company we file taxes as a C corporation. My boss was receiving a salary but stopped in 2005 and started drawing money out of the drawing account. Since then he has withdrawn $200,000.00 from that account. He did this by paying his personal bills - no direct checks to himself - all to the utilities, mortgage and automobile companies. We have a lady that does our tax preparation. Where would I find these amounts on our tax returns? She files Form 1120 for Federal and 20C for State.

As far as their personal tax returns we also pay what they owe at the end of every year. It is usually under $500.00. My other question is where is the reporting for the $200,000.00 (around $60,000.00) a year go?

If it's not on our corporate tax returns and I am guessing not on their personal because they would owe a lot more if it was, would it be considered unreported income?

ANSWER: Something doesn't add up.  If it's an LLC organized like a C-Corp, then there is no such thing as an "owner draw" account.  That can only occur in a partnership or sole proprietorship.  So, if it's actually a C-corp, then all of these payments would be dividends.  They would show up on Schedule M-2, which is on the bottom of the last page of the 1120.

Dividends are claimed on the owner's Schedule B of their 1040.

When a taxpayer receives a lot of income through sources that do not withhold taxes (like dividends), they are responsible for paying taxes quarterly.  If they don't owe much each year, then they're paying quarterly estimates.

Hopefully that answers your question.  Please let me know if you need any further clarification.

Happy holidays!
Vanessa

---------- FOLLOW-UP ----------

QUESTION: She told my boss he could withdraw from the drawings account. I told him at the time and since that I didn't think that was right. There is nothing under Schedule M-2. They do not make quarterly payments. I have been worried since this started in 2005 that this isn't right.

2006 - $45,386
2007 - $57,583
2008 - $68,500
2009 - $29,645

These are the amounts from every year (from his drawing account) and I am sure it is all unreported. She has reported our total earnings correctly. So does that mean since the company has paid taxes on the total income that my boss doesn't owe taxes for the amounts he has withdrawn?

Also, as I mentioned, all these amounts were written out to companies to pay his mortgage and all of his personal bills. I am concerned that this is unreported income to him. He is the only owner of the company but in May he did put his wife on the payroll and stopped drawing from the drawing account.

Thanks Vanessa for all your help.

Answer
Hm.  Something is fishy.  If there is an owner draw account, then it's not a corporation.  But you have a 1120.  If it's a corporation, then all of these draws would be dividends, but there's nothing on the M-2.  What is the other side of the entry?  If you credit cash and debit the draw account, then where is the balance in the draw account reported?  Hm.  Maybe they're doing something funny with equity.  How about with the personal bills?  What's the other side of the entry?  Are these debits also to the draw account?  The only way that could work is if they're incorrectly adjusting equity for these amounts.  The whole thing doesn't make any sense.  If he's receiving amounts (whether in the form of personal bills paid or actual "draws") then he should be reporting it as income.  If it is actually a Partnership, then the draw amounts aren't income, but ALL of the earnings from the business would be reported on his personal return via a schedule E.

Unfortunately, you seem to be stuck between a rock and a hard place.  I don't envy your position.  What you can do, if you choose to, is to notify the IRS of your concerns.  Go here:
http://www.irs.gov/individuals/article/0,,id=106778,00.html

You can download the form there and get further information.  Also, if you look here: http://www.irs.gov/compliance/article/0,,id=180171,00.html
you can get information on the whistleblower rewards program.  I'm not sure if the case meets the requirements, but you might want more information.

Best of luck to you- hopefully it all works out.
Vanessa