IRS wins case on S-Corp compensation

[veritas]

Some method was used to compute the accountant's wages (not described). The IRS now has precedent to attack others.

http://online.wsj.com/article/SB10001424052748703951704576092371207903438.html?mod=WSJ_hp_MIDDLENexttoWhatsNewsForth

[Snaggletooth]

Forked Objectives

I don't have any problem with this so long as the IRS uses the same criteria to establish Scorp salaries as they do Ccorp salaries.

High C corp salaries cost the gubbermint $$.
Low S corp salaries cost the gubbermint $$.

[JohnH]

If I understood the numbers right, this is actually encouraging. The $24K in salary and $204K / $175K in distributions for each year were clearly ridiculous. But even after IRS made their adjustments, his situation was $94K in salary and $137K / $$108K in distributions for each year. That's much more in distributions vs salary that I would expect to be reasonable for a service corp - less than 50% of the total in salary each year. It's more aggressive than anything I'd ever advise a client to do.

[Bees Knees]

If I understood the numbers right, this is actually encouraging. The $24K in salary and $204K / $175K in distributions for each year were clearly ridiculous. But even after IRS made their adjustments, his situation was $94K in salary and $137K / $$108K in distributions for each year. That's much more in distributions vs salary that I would expect to be reasonable for a service corp - less than 50% of the total in salary each year. It's more aggressive than anything I'd ever advise a client to do.

You will notice, however, that the goal is to eliminate the benefit of being an S corp by maxing out (or close to max out) Social Security wages. With wages that high, there is not much tax difference between the S corp and if it were a Schedule C. If I have a client that says he hears he can save self-employment tax by converting to an S corp, this case proves he really can't save that much, or as much as we use to try to save.

[ttbtaxes]

$24K in salary, $175 in distributions. The accountant got what he deserved.

Pigs are fed but hogs get slaughtered.

[JohnH]

I missed that. So IRS's position isn't so much the ratio, it's driven more by the SocSec max. As long as they can produce a revised slaary close to that figure, they've achieved their main objective. It the distribution were $80K for example, they're still likely to try for a $66K addition to the $24K salary, leaving only a $14K distribution. That makes sense from their perspective.

[ttbtaxes]

I'm not sure of their motives but clearly the accountant's services were worth more than the $24,000 W-2 he decided to pay himself. Moreover, considering the corporation is in a service industry, rather than an asset-intensive one, I'd expect most of the monies he withdrew to be for his services.

The IRS efforts bear little fruit once the change exceeds the FICA limit. Speaking of fruit, Watson was low-hanging fruit who was picked as easily as a September apple.

[Bees Knees]

IRS motives are to collect FICA taxes on income that would be subject to SE tax if it were a sole proprietor. This is just a rare case that actually made it to court, but for years now, IRS auditors have been telling the CPA or EA representing the taxpayer that if they will agree to max out Social Security wages, the audit is done.

[veritas]

I am sometimes amused

that IRS is so eager to collect as much money as they can. If every dollar of S-Corp earnings were converted to wages and the entire tax gap was closed they would only need about one more trillion dollars to balance this year's budget.

[JON]

My only question

is how long can appeals take to have 2002 and 2003 decided now??? The decision is obvious, how much did the guy spend defending $24,000. What do you think is the status of 2004 to 2010??? Iowa is the "hog" state. If anyone gets an updat on the other years let us know.

[erchess]

Bottom Line

Suppose that a single owner S Corp has net profit and perhaps even gross revenue under the maximum for social security wages. What guidance can we give on the question of what to call wages and what to call distribution? One bit I have picked up on is that the more capital investment is a factor in generation of the income the lower wages can be. One person in the article suggested that for a personal service business such as law, medicine or accounting 70% of profit would be a minimum amount to put as salary. I also understand that you have to ask yourself and perhaps a labor market expert what the owner would have to pay a qualified person to work for wage or salary without equity and do all that the owner is presently doing.

[JohnH]

That's the dliemma. I wouldn't have the nerve to ask a qualified person to do what I'm doing, especially if I paid them as little as I'm paying myself.

[oceanlovin'ea]

I have preached to my s corp shareholders for years...."you have to have reasonable compensation." I also ask them what they would pay someone to do what they are doing and tell them you should pay yourself somewhere close to that.

I only had a few and now a few less than a few left after some businesses closed. But I feel pretty confident that most of mine are doing a good job. For most, salary is higher than distributions and higher than net profit. But with a couple of people, it took a while for them to understand.

Linda

[ttbtaxes]

It's ironic. We wrestle with the IRS to convince them that the S corp owner's services are really only worth the little they were paid. In the next breath, we explain to the IRS that the C corp owner's services are worth every bit they were paid, and more!

Some knives cut both ways.

[Gretel]

Besides IRS trying to collect close to SS limit, I was taught in a seminar that the most important factor is how much you would pay someone else to do the job and basing this on research with employment agencies. There was one agency that stood out for accuracy, but I am not close to the source and neither am I sure I could find this info fast.