Shareholder/Officer Compensation

[geekgirldany]

I know this has been talked about before in other posts. But today I got a new client/ Individual and S-Corp. His CPA which has been practicing for 40 years and jus retired. S-Corp nets from $15,000 to $20,000 a year. Client would take draws in those amounts give or take a little.

Now this CPA has been preparing his taxes for over six years showing no payroll. Only Distributions. Client comes to me and I tell him he should have been doing payroll all that time. To which he said CPA told him he wasn't making enough to do payroll.

I spent about an hour going over with him about S-Corps and payroll. How do these S-Corps go so long without paying Officer Salary and not get caught by the IRS? I felt like I was put in the position of he was a CPA for 40 years experience... he knows.

Am I missing something on officer compensation? This makes the fifth one I've seen like this.

Dany

[jimmcg]

I know this has been talked about before in other posts. But today I got a new client/ Individual and S-Corp. His CPA which has been practicing for 40 years and jus retired. S-Corp nets from $15,000 to $20,000 a year. Client would take draws in those amounts give or take a little.

Now this CPA has been preparing his taxes for over six years showing no payroll. Only Distributions. Client comes to me and I tell him he should have been doing payroll all that time. To which he said CPA told him he wasn't making enough to do payroll.

I spent about an hour going over with him about S-Corps and payroll. How do these S-Corps go so long without paying Officer Salary and not get caught by the IRS? I felt like I was put in the position of he was a CPA for 40 years experience... he knows.

Am I missing something on officer compensation? This makes the fifth one I've seen like this.

Dany

You are not missing something. The requirement has always been to pay "reasonable compensation." The Service has only recently increased their enforcement of this and has updated their software selection criteria to pull out these types of situations which are not paying "reasonable compensation." Odds are your new client will be selected for audit for open years and you will get the opportunity to represent him. Look at it as a revenue enhancement opportunity.

[oceanlovin'ea]

Hopefully he will stay a client for you. It is very difficult to make them see that the old CPA wasn't doing things the way IRS tells them to do it.

You might tell him that "some" CPA's don't keep up with the tax law changes and what IRS is doing as much as others. Since their continuing education covers more than taxation, he might not have known IRS' new approach to S corporations.

Show it to him in writing from the pages of IRS website. Tell him this is the way IRS says to do it. As enrolled agents we are required to follow the guidelines of IRS.

Make the payroll as easy for him as possible. One check once a month for a certain amount. Show him how to make payment for payroll taxes on EFTPS or make them for him. Do his quarterly reports for him. He will find out it is not as scary as he thinks.

Hope it works out.

Linda, EA

[WhiteOleander]

I have wondered about a situation with an S-Corp I prepare.

The employees are paid as "leased employees". This includes the only S-Corp shareholder. He does take a very reasonable salary. However, it is not paid to him in the EIN # of the s-corp. There are no W-2's, 941's etc filed under the s-corp name.

So, if the wages for the officer are put on the correct line (line 7 I think) there are no W-2's or payroll reports for the IRS to match to.

What do all of you do in this situation?

[JG EA]

So, did shareholder count on Sch C? If so in an audit I think he would have very little to worry about although done incorrectly - IF it were "reasonable" that is.

[jimmcg]

I have wondered about a situation with an S-Corp I prepare.

The employees are paid as "leased employees". This includes the only S-Corp shareholder. He does take a very reasonable salary. However, it is not paid to him in the EIN # of the s-corp. There are no W-2's, 941's etc filed under the s-corp name.

So, if the wages for the officer are put on the correct line (line 7 I think) there are no W-2's or payroll reports for the IRS to match to.

What do all of you do in this situation?

If you are saying that the "employees" are paid and no related payroll taxes for them are paid then the answer is obvious...........Who are they really being leased from? Best to get all the facts prior to reaching a conclusion.

[WhiteOleander]

The corp has the same employees all the time. It is in the construction industry. The rates for workers comp and unemployment go up if a claim is filed against the company. So, companies lease their employees from a leasing company. The employees, including the shareholder, receive a w-2 from the leasing company, not the corp. In this case, the s/h received a w-2 for close to 100,000.00. He certainly has taken reasonable compensation. The corp pays the employees on w-2, not 1099's. There is even a SEP plan for them. The corp also pays health ins for the employees.

But, since the w-2 for the s/h is not in the corp name, I do not put his compensation on that line.

This payment arrangement is done a lot here because of the rates going up for workers comp and unemployment. The corp gets to keep their lower rate.

[AZ-Tax]

"The corp pays the employees on w-2, not 1099's"?

The corp has the same employees all the time. It is in the construction industry. The rates for workers comp and unemployment go up if a claim is filed against the company. So, companies lease their employees from a leasing company. The employees, including the shareholder, receive a w-2 from the leasing company, not the corp. In this case, the s/h received a w-2 for close to 100,000.00. He certainly has taken reasonable compensation. The corp pays the employees on w-2, not 1099's. There is even a SEP plan for them. The corp also pays health ins for the employees.

But, since the w-2 for the s/h is not in the corp name, I do not put his compensation on that line.

This payment arrangement is done a lot here because of the rates going up for workers comp and unemployment. The corp gets to keep their lower rate.

I have a client who has an "employee" leasing business and files a Sch C (solely owned by client). He describes his structue the same way but I am a little confused WhiteOleander when you said "The corp pays the employees on w-2, not 1099's". Its my understanding the corp (client of the leasing co.) pays the leasing company a fee. That is the corp's only obligation.

[AZ-Tax]

Geekgirl, happen to me as well

I had a new S-Corp client call me this spring and their CPA was only having them take a very small w-2 salary. I sent the WSJ article about how the CPA firm in IA fought the IRS and lost. Client went to another CPA fim. I picked up an S-Corp client last year whose CPA too was instructing her (the shareholder) to take small w-2 wage and she was smart enough to figure out that is probably not going to fly but her situation has changed recently and she has very little involvement in the S-Corp's day to day operations. Is it possible she could get away with 100% of the S-Corp net profits be Sch E taxed and she takes NO w-2 salary?

[ChEAr$]

A corporate officer who is also a 2%'er is a statutory employee of the corporation. So one might think that he MUST take a salary from the corporation.

However, in a similar construction business audit covering two years, the fact that his salary was included in that of the leased employees was never questioned by the auditor.

After all, he was getting a reasonable salary.

[WhiteOleander]

A corporate officer who is also a 2%'er is a statutory employee of the corporation. So one might think that he MUST take a salary from the corporation.

However, in a similar construction business audit covering two years, the fact that his salary was included in that of the leased employees was never questioned by the auditor.

After all, he was getting a reasonable salary.

Thanks, that's what I was wondering about.

[geekgirldany]

I appreciate everyone posting on this. I suppose the client eventually could tell (after an hour of talking) I knew what I was talking about. I told him if he wanted another opinion on the subject I would understand. He told me no he would go with me. Az-Tax thanks for that reference article from WSJ. I seem to have him as a client now but will go ahead and provide him with a few references like Linda said.

I know that this will probably take the thread in another direction... but when do you recommend a client become a S-Corp? Use to recommend that a client not incorporate until they netted $60,000. Then depending on their standard of living they may could take distributions to lower the tax burden. Now I am starting to rethink advice and wondering if liability issues would be the only reason someone would be a S-Corp.

Would you even recommend to someone such as this client netting $20,000 a year to go to a Schedule C with LLC to cover him as liability?

Most of the time... I am not given the choice to give advice as they have already done it themselves. Just wondering what advice you all give.

Thank you
Dany

[RitaB]

Well, yeah

Is it possible she could get away with 100% of the S-Corp net profits be Sch E taxed and she takes NO w-2 salary?

Well, yeah, it is. Potential client did this for ten plus years. He asked me about doing his bookkeeping when his preparer retired. I just told him what that he should have been taking a salary and declined the job. One factor was the lack of payroll, but the big one was that he somehow lived really well on that $20,000 a year net profit. It was miraculous, actually. Not worth it to me.

[ChEAr$]

The liability issue is the biggest reason for either an LLC or corporate entity. So a proprietorship might have enough insurance to cover everything and not need legal protection.

One other factor in favor of an S corporation at least is goodwill. Just because an S corp is in place doesn't mean that all profits must be paid to 2%'ers who are officers. Much of the profit before officer/owner salary can be said to be attributed to goodwill established over the years. In my case, the name "Accutax Services" (an Alabama corporation) has built up a lot of goodwill during the last 37 years and therefore my return on investment takes this into account with only a reasonable salary.

[oceanlovin'ea]

Dany, I am at the GAEA convention right now. Beanna Whitlock is the primary speaker. She talked this morning about choice of entities and how to help client choose best for his situation.
When I get home later in the week, I will send you an email and share some of those points with you.

Linda, EA