What were they thinking?

[Unregistered]

Met with new client today, owns S-Corp 51-49 with wife. Husband takes W-2, wife does not (no services provided). Net income for S-Corp last year was roughly $300,000, husband took W-2 for $150,000. Said old accountant told him, "If you don't max out on SS the IRS will flag your company and audit you." I told him she was smoking crack and must be scared of an auditor because I wouldn't give him a W-2 for a penny over $30,000. The company is a sand and gravel delivery business, and he only provides administrative services (basically goes to the office about 20 hours a week and makes sure all the vendors are getting paid and all the customers are paying their bills).

What in the world would make an accountant give this type of advice, and is there anyway we can go back, redo the 941's, issue a new W-2 and get this guy a refund? I know it will cost him about $1000 in fees, but he would save several thousand in tax.

JoshInNC

[Uncle Sam]

What Where they Thinking?

By the explanation you gave it's not quite clear.
I would guess that what the other accountant was trying to do was to maximize salary so that IRS wouldn't think he was taking a below-reasonable salary in order to take the profit out in distributions, avoiding the withholding of Social Security and unemployment insurance issues.

[jainen]

reasonable salary

$150,000 seems like a reasonable salary for the owner/manager of a construction firm. $30,000 is what they would pay a receptionist.

[S T]

Compensation

Not sure Josh,

But I would think that if the Company netted $300,000 then the S Corp shareholder (husband) even at 20 hours a week is doing something right. If he were employed by another sand and gravel company would that be his salary at $150K??? I would hope so for the profits that he has made with this Company.

Personally I wouldn't touch the already issued W-2 forms, and form 941 forms. That really would be opening a "can of worms".

Analyze the Company and see what you can offer to minimize the profits or establish some type of retirement accounts, etc.

Sandy

[Snaggletoof]

Let the Dog Lie

Josh, some accountants run scared of the IRS, and I believe this yay-hoo was very much afraid IRS would expect the owner to max out his social security. Naturally, when you put more compatible numbers into a calculator, he will have less tax. I agree that the other accountant gave him bad advice.

However, make your changes in the years to come, and don't re-issue W-2s and redo tax returns for prior years. Unless, of course, you are comfortable confronting the IRS on the issues above as an explanation of your changes.

[Unregistered]

I think we'll just move forward with the new numbers.

Jainen, there is no way I would let any of my S-Corps take a salary of $150,000, no matter what they do for a living. I have an optometrist who only takes $45,000 a year.

The IRS has never won a case where the taxpayer took a salary, irrelevant of it's size.

[Gretel]

The IRS has never won a case where the taxpayer took a salary, irrelevant of it's size.

Doesn't mean it will not happen in the future. We are talking about reasonable and I agree with Jainen that $30,000 is not reasonable but $150,000 isn't either.

If he has a number of employees it would justify a lower salary since they are making the money for him. If I understand your post correctly, he has a manager and is not responsible for all management descisions, which also justifies a lower salary. Only you know all the details and need to make a judgement call.

I don't think it's a good judgement call if it is just based on "The IRS never won..."

[jainen]

more than persuasive

>there is no way I would let any of my S-Corps take a salary of... <<

Most accountants don't hold such veto power over their clients' business decisions.

SE tax is not an evil thing in itself, and there are many different issues, non-tax and even non-business, in setting a higher salary. To name just a few -- it allocates income away from other shareholders, it justifies maximum fringe benefits, and it builds personal credit. It might even be a requirement for local government contracts, an absolute for a gravel company. And of course prior contact with the IRS might be more than persuasive.

[JoshinNC]

Where's Matt Sova when you need him?

I bet Matt is chomping at the bit on this one. He'll most likely chime in that the salary should be one penny higher than the state unemployment tax maximum and no more (which I tend to agree with).

Come on Matt, HELP!

[outwest]

Looking at the big picture...

$150K would give you enough earned income to max out a proper 401k plan. 'Course you may not want to contribute to those pesky employees.

And I should point out that some recent IRS audits in my area have asked the question from the bottom up: What is the distribution/salary ratio? hmm...

Doug

[Safire]

I doubt any other firm would pay out 1/2 of their profits to the managers salary. 150k is way too high.

But I agree, don't go back and change it.

[rosieea]

I think a $30K salary with $270K pass-through income would be pushing the envelope. There could be good reasons for doing that way, and I'd want to be armed with them, because I wouldn't be surprised if that situation prompted an IRS inquiry. Have you seen the IRS letter approving S-Corp elections? There's a paragraph emphasizing that reasonable salaries must be paid. Given Everson's priorities, I believe that S-Corporations will be closely scrutinized on this issue.

[Zee]

Jainen, there is no way I would let any of my S-Corps take a salary of $150,000, no matter what they do for a living. I have an optometrist who only takes $45,000 a year.

The IRS has never won a case where the taxpayer took a salary, irrelevant of it's size.

Is it true that the IRS has never won a case where the taxpayer salary was determined to be unreasonably low? Can someone confirm this?

[sea-tax]

When clients ask me my usual response is two fold what would you pay somone to do what you do for the corp or take your highest paid employee and add 15-20% for management duties and there ya go. The salary must be reasonable and this seems like an reasonable solution to me.

Basically if all of us intelligent people can't agree to what reasonable comp. is how can we expect our clients to understand it.

[jainen]

be more than persuasive

>>my usual response<<

There are many different issues, non-tax and even non-business, in setting a higher salary. To name just a few -- it allocates income away from other shareholders, it justifies maximum fringe benefits, and it builds personal credit. It might even be a requirement for local government contracts, an absolute for a gravel company. And of course prior contact with the IRS might be more than persuasive.