S-corp and audit

[NewPerson864]

I have heard the IRS is conducting a comprehensive program to audit every single S-corp due to the SE tax on dividend and W-2 wages issue.

My clients often inquire me about this issue. Is it safe to tell them that it is inevitable that they will get at least one audit within the next 5 years?

[BHoffman]

Curious - where did you hear that?

[Jiggers]

S-Corp audits

I don't know about all S-Corps, but they are auditing S-Corps with no officer wages and net profits and/or shareholder distributions.

[ChEAr$]

IRS doesn't have the manpower/womanpower to audit EVERY 1120S. So they will use
their computers to select the ones with either no salary and a profit or minimum salaries
with profits.

So our real question is at what level of salary versus profit will the computer flash the
red lights.

[S T]

No recent reference

I have heard the IRS is conducting a comprehensive program to audit every single S-corp due to the SE tax on dividend and W-2 wages issue.

I searched my IRS Quick Alerts, and NAEA and a couple of other sources that I receive, and I can not locate any recent reference (last few months) to accelerating the audits of S Corps (every S Corp return)

However, I do believe the program in the past has been successful, and IRS and/or States will continue to look at S Corps, if there is an absence of "reasonable compensation" reported for shareholders on a W-2 and if distributions are "too high"

Sandy

[BHoffman]

Would like your opinions

I believe the red light might flash but the client will be protected from audit changes if they pay themselves reasonable salaries. I use sites like salary.com or others to try and determine what is reasonable.

I wish there were more "hard and fast" rules regarding this issue.

What do you all think of the following?:

Profits at $40k. Drawings at $25k. Salary.com says reasonable salary is $50k. What amount do you think this shareholder should receive in salary? I've read elsewhere that the IRS probably won't insist to see more than the amount of drawings as salary if profits are lower than reasonable salary, but believe that is just someone else's opinion. Like very much to know more about that.

Or the reverse -

Profits at $300k. Drawings at $250k. Salary.com says reasonable salary ranges $80k - $100k. He's (say) a web designer. He works from home and has no overhead or employees. He puts in 20 hours a week. What would reasonable salary be for this fellow?

Thanks for your time in considering these issues.

[JON]

You may not

have to worry about reasonable comp in an S corp after 2009. The head of the House Ways and Means has his bill taxing for SE purposes all UTI to stockholders who are also employees of the company. The IRS had the 2003 audit sample of S corps and then the 2005 audit sample. They seemed to conclude that the number of S Coprs had grown enormously from 1998 forward and they believed one of the main reasons was the advantage of controlling the FICA wages. Remember the IRS really does not want to audit for SE changes, but the white papers they wrote after the two times they sampled pretty much said this area was being abused and should be changed. The Social Security Admin then took the numbers and came up with they could have collected and then the political part started. It was already in his 2007 bill that he did not submit- politics.

If a sole proprietor manufacturer reports on a a 1040 Schedule C he pays SE on all his earnings. Why should the choice of an operating enity make a difference to how much goes to Social Security? That was his comment.

[ChEAr$]

I believe the red light might flash but the client will be protected from audit changes if they pay themselves reasonable salaries. I use sites like salary.com or others to try and determine what is reasonable.

I wish there were more "hard and fast" rules regarding this issue.

What do you all think of the following?:

Profits at $40k. Drawings at $25k. Salary.com says reasonable salary is $50k. What amount do you think this shareholder should receive in salary? I've read elsewhere that the IRS probably won't insist to see more than the amount of drawings as salary if profits are lower than reasonable salary, but believe that is just someone else's opinion. Like very much to know more about that.

Or the reverse -

Profits at $300k. Drawings at $250k. Salary.com says reasonable salary ranges $80k - $100k. He's (say) a web designer. He works from home and has no overhead or employees. He puts in 20 hours a week. What would reasonable salary be for this fellow?

Thanks for your time in considering these issues.

It's all facts and circumstances, a phrase we all know and love.

However the term we use is distributions, not drawings. but anyway.

Case # 1:Salary.com may be a reasonable starting point of course, but any salary
before profits more than profits, is way too much. Factor in also in all cases, a
suitable return on investment (ROI) and the intangible factor of goodwill.

This case, assuming it is a well established business, salary of $20,000 might be
reasonable. This case differs from # 2 in that

in Case #2, there is only labor involved, and negligible expenses.
Reasonable salary for this fellow would certainly be closer to profits, since it's all
his own labor intensive, and similar to personal service income. The fact he only
puts in average of 20 hours a week is immaterial. IRS would go after the whole
enchilada.

[Gretel]

In a recent seminar I heard that going through a questionnaire available at www.payscale.com and then print it out for the records will stand up in an audit. I think this is what the IRS uses also.

[JG EA]

...
in Case #2, there is only labor involved, and negligible expenses.
Reasonable salary for this fellow would certainly be closer to profits, since it's all
his own labor intensive, and similar to personal service income. The fact he only
puts in average of 20 hours a week is immaterial. IRS would go after the whole
enchilada.

I don't think that is true at this time. Although as has been pointed out it may be true for everyone soon. But it is a corporation and the only requirement at this time is "reasonable compensation" not whether you do all the work yourself.

[AuditorTurnedGood]

I don't think that is true at this time. Although as has been pointed out it may be true for everyone soon. But it is a corporation and the only requirement at this time is "reasonable compensation" not whether you do all the work yourself.

I think the IRS actually would have a good argument to make it all salary. If you think about salary itself, it is paid to an employee to compensate for their time and efforts. If all of the profits of the company are created by the time spent by the employee/owner, and there are no assets to speak of or other employees that do any of the work, (or creating any of the profits), why wouldn't it all be salary?

[Gretel]

...because you could hire someone to do the work and only that salary would be subject to payroll taxes. You still have goodwill and investments in office and office equipment.

[AuditorTurnedGood]

...You still have goodwill and investments in office and office equipment.

Agreed. But, in a personal service business, are those assets actually producing income? The income itself is produced by the efforts of the employee. (BTW, I'm not on the side of this being the right answer, just one possibility to keep in mind). Let's remember that "reasonable compensation" is nearly as well defined as "realistic possibility"

[JG EA]

Agreed. But, in a personal service business, are those assets actually producing income? The income itself is produced by the efforts of the employee. (BTW, I'm not on the side of this being the right answer, just one possibility to keep in mind). Let's remember that "reasonable compensation" is nearly as well defined as "realistic possibility"

OK actually you make a point that is on the minds of lawmakers, but "personal service" corporation is not a designation for an S-Corp. Do you not agree that the rules at this time do not put on these requirements?

[ChEAr$]

OK actually you make a point that is on the minds of lawmakers, but "personal service" corporation is not a designation for an S-Corp. Do you not agree that the rules at this time do not put on these requirements?

Note, that ATG used the term "personal service business", and not personal service corporation, which we all know doesn't relate to an S corp.