Reasonable Compensation for S Corp

[veritas]

I had a recent audit so I got some schooling. The fact of the matter is the agents are flying by the seat of their pants. I will give you some reasoning for distributions that you might find interesting. The agent proposed a 10% return on the clients investment. He originally proposed using the tax basis which was very low. Then without our arguing he proposed valuing the business with the going concern value which increased the value dramatically. I'm not saying I agreed with his position however it could work to some client's advantage. So for example you have a small business valued at one million would allow a return on investment of 100,000. So let's say the business earned 150,000, by his reasoning 50,000 would be reasonable compensation.

Then again you could use the John Edwards approach. Earn 5 to 6 million a year as a sole prop attorney then incorporate and elect s-corp status. New reasonable salary 500,000. Savings a cool half million in medicare taxes.

[OldJack]

The IRS doesn't care about distributions, because distributions don't affect taxable income (unless the distributions go above the shareholder's basis). What they do care about is reporting income as S corporation earnings instead of wages assuming the earnings are the result of personal services.

Armando, if you look at every case the IRS has taken to court for reasonable salary it was because the shareholder had taken non-taxable cash distributions instead of salary. No distributions no problem with reasonable salary.

[Armando Beaujolais]

As a CPA I am offended by these types of remarks. There are lots of theories on reasonable wage, but the fact of the matter is there is nothing in the tax law that defines reasonable. That said, if someone is given a 1099-MISC that is just plain incorrect. I have seen EA's, CPA's and unlicensed preparers do it. By law if you are an officer of a corporation you are an employee and therefore you cannot get a 1099.

I have single owner S-Corps taking 12,000 or 18,000/year wages. Reasonable? You may think not, however, lets look at an arguement to prove that it is.

Minimum wage is $5.15/hr x 40 hrs/wk x 52 wks/yr = $10,712 per year. If the gov't calls 5.15/hr reasonable then 12k/year is above that amount. Aggressive? Sure it is. Does not mean that it is incorrect.

Matt

It's incorrect that there's "nothing in the tax law that defines reasonable." The tax code says wages have to be reasonable. Courts define "reasonable" all the time.

I believe you're really stretching here. You can't just throw out numbers and determine whether the numbers amount to reasonable compensation. Just as with most things in tax law, there are facts and circumstances that, by law, need to be considered.

No, the government does not call $5.15 an hour "reasonable." They call it "minimum." But it doesn't matter because minimum wage is irrelevant. I've never seen minimum wage cited in any of the court cases I've read regarding reasonable compensation.

You could argue that a reasonable wage for a heart surgeon or the CEO of a major medical supply company is $5.15 an hour and call it "aggressive." Of course, it's not aggressive, it's simply ... unreasonable.

[JON]

Get a life

I have been a CPA since 1975.

[Matt Sova]

Cpa

Those darn prior CPAs .................. Never do what they did...

As a CPA I am offended by these types of remarks. There are lots of theories on reasonable wage, but the fact of the matter is there is nothing in the tax law that defines reasonable. That said, if someone is given a 1099-MISC that is just plain incorrect. I have seen EA's, CPA's and unlicensed preparers do it. By law if you are an officer of a corporation you are an employee and therefore you cannot get a 1099.

I have single owner S-Corps taking 12,000 or 18,000/year wages. Reasonable? You may think not, however, lets look at an arguement to prove that it is.

Minimum wage is $5.15/hr x 40 hrs/wk x 52 wks/yr = $10,712 per year. If the gov't calls 5.15/hr reasonable then 12k/year is above that amount. Aggressive? Sure it is. Does not mean that it is incorrect.

Matt

[BOB W]

Good point....

.. here in NY SUTA (NYDOL) it is almost an automatic audit when Officer wages are below $8,500. If there are officer loan repayments or no distribution, they will not change the filed reports. Otherwise, they go back three years.

[Gretel]

I have a question related to this issue. I frequently have new clients with S-Corps who have never wanted to go through all of the headaches related to payroll and their prior CPA's have allowed them to take their "reasonable compensation" using a 1099-Misc and then claiming it on a Sch C on their personal. While I do not recommend this, particularly for years forward, is this a problem for year's past? Or for year's future for that matter?

The prior CPA's have maintained that all of the taxes were paid so no harm was done. Incidentally, they have always put the amount paid on the 1099-Misc on the "Paid to Officers" line.

What say you?

They conveniently forgot about FUTA and SUTA. My state unemployment office would love to see that.

[BOB W]

Old Jack

No profits......... That is why I started my original reply with "Officer's contribution to Net Profits". If profits are zero no Officer Payroll is needed. If you choose, some officers may want SS credit instead of their annual SS report being zero.

[JON]

Proir CPAs

Those darn prior CPAs .................. Never do what they did...

I have a question related to this issue. I frequently have new clients with S-Corps who have never wanted to go through all of the headaches related to payroll and their prior CPA's have allowed them to take their "reasonable compensation" using a 1099-Misc and then claiming it on a Sch C on their personal. While I do not recommend this, particularly for years forward, is this a problem for year's past? Or for year's future for that matter?

The prior CPA's have maintained that all of the taxes were paid so no harm was done. Incidentally, they have always put the amount paid on the 1099-Misc on the "Paid to Officers" line.

What say you?

[Armando Beaujolais]

What about a S-corp that has no profit but incurrs a large loss with no funds for officer payroll?

Also, at least in the past the IRS was only interested in officer salary if the officer was taking cash distributions instead of salary. If there is no distributions Is that no longer looked at?

You don't have to pay salary to a shareholder if there's no profit.

There are a lot of criteria, but the one that's relied upon the most is the independent investor test. What would an independent investor who had no connection pay under the same circumstances for the same work?

The IRS doesn't care about distributions, because distributions don't affect taxable income (unless the distributions go above the shareholder's basis). What they do care about is reporting income as S corporation earnings instead of wages assuming the earnings are the result of personal services.

In the past the IRS has only gone after S corporations that paid little or no wages and had relatively high S corporation earnings. An S corporation could pay very little in wages and get by with it, even when it was obvious that the earnings were from personal services. Everything I've read about this from the IRS says they're going to take a much closer look at the issue of S corporation wages. I think the days might be over where a sole proprietor in a service business can change to an S corp and then pretend that 90% of their income is from something other than personal services.

[OldJack]

A good preparer would not let officer payroll be zero.

What about a S-corp that has no profit but incurrs a large loss with no funds for officer payroll?

Also, at least in the past the IRS was only interested in officer salary if the officer was taking cash distributions instead of salary. If there is no distributions Is that no longer looked at?

[Bees Knees]

Under links above, the general category, there is a link to salary.com which gives you an idea of what a reasonable salary is per location and job description.

[S T]

Trade or Industry

Reasonable compensation for that trade or industry and what the job duties consist of. Secretary = $xx, Administrator = $xx
S

[veritas]

I would agree no compensation is a problem. I believe the service is using computer modeling to find high income S Corp returns with no or low officer compensation.