Ricky Nelson is an engineer who is the only shareholder of Engineering Services, Inc., an S Corporation, and he is a married individual filing a joint tax return with his spouse. The S Corporation’s income is most of his income on their tax return.
The corporation offers power system protection services. He also has 8 employees working for him with wages of $500,000. Nelson does not receive
any regular payments from the corporation as compensation, but he withdraws funds as the need arises. During the current year, he withdrew $825,000, and the net income of the corporation is $1.000,000. The corporation does not deduct the $825,000 of withdraws, nor does Nelson include it in gross income. Nelson does, however, report the $1,000,000 from his S Corporation K-1 in gross income on his Schedule E prepared by his CPA.
Because Nelson has recognized the corporation’s income in his form 1040, he sees no reason to pay himself a salary. He justifies the treatment by arguing that he is not an employee (i.e., he is the owner) of the corporation and that the Federal and State income tax consequences are identical.
Questions:
Do you agree with Nelson? What are the issues with the position that Nelson is
taking if any?
What do you think he should do if you don’t agree with Nelson?
Would your answer change if the entity was an LLC or C Corporation?
What entity do you recommend for Nelson?
If the facts are not present to answer the question you must provide your
assumptions in your research memorandum.

Resources and requirements:
Use the tax resources (CCH and RIA Checkpoint) to research and answer your
questions above. Make sure you address all types and aspects of taxes. Your research
should be written in a memorandum-see format below. Your memorandum
should be at least 1,000 words.

TAX FILE MEMORANDUM

To:
From:

SUBJECT:

FACTS:

ISSUE:

CONCLUSION:

DISCUSSION AND ANALYSIS: