Tax question

[demejoe]

Greetings

This scenario is in regards to a client I consult for, they are a small business of 3.

 

 

The client has a business that has been operating for roughly 3 years. Recently they officially signed paperwork for a partnership, they had been running as sole proprietor in the past. Here is what they are doing and I am seriously questioning this. They are taking all the money they make and placing it in a business account. The problem is they are not paying any taxes. I told the head of the company that they should be paying taxes because its money they made. He says that as long as the money is sitting in the bank, they dont have to pay any taxes on it because they are not pocketing any of it. I told him I dont think the IRS cares if they pocket any of it or not, because its income earned and they should be paying quarterly taxes. He thinks I am just trying to scare him, I assured him I wasnt but I didnt want to see his accounts frozen by believing something that may very well be inaccurate. So who's right/wrong

[miamijc]

Your client is dead wrong. Income is income when it is earned. Delaying removing money from the business account has no effect on when it is taxed. WIth some business entities (for e.g., a C Corporation), if the money remains in the entity it is taxed only at the entity level. With a partnership, the partners recognize the income of the partnership whether or not a distribution from the partnership is made to them. Therefore, if no distribution is made, they still recognize this "phantom income", and must pay taxes on it. The partnership should be issuing them K-1s at year end.

 

If this is their first year (I could not tell from your question exactly), they may not have to make additional estimated payments individually, as they can rely on the safe-harbor of making estimated payments based on last year's income. It sounds like in all events they need an accountant or an attorney to sort things out, because they are likely just getting themselves into a very large headache (and possibly much worse).