Let's talk reasonable compensation for a sec: In this specific scenario, my client was an employee of a company in 2021, making $145k/year. For 2022, he has gone out on his own, formed an S Corp, and is getting $175K from his old employer as a contractor. After expenses he is looking at about $140K net income. If we use the Kohler Payroll Matrix, $50K is "reasonable". However, I worry that his 2021 salary could hurt his reasonable salary argument. What do you think?
-
-
So he apparently did the same job as an employee for company X and as an employee of his new Scorp company Y - is that correct?Originally posted by DebitThatCreditThis View Post
X paid him $145K which is quite far away from Y paying him $50K. Are you smiling when you think $50K is reasonable?
-
Has he really "gone out on his own" if his only customer is his former employer?
Does he have any investments in employees, capital or equipment?
Is anything other than his time, knowledge and efforts generating revenue?
Could he hire someone for 50K to do the income generating work?
I certainly hope that with the additional resources, the IRS finally starts going after some of these "reasonable" compensation wages.
Comment
-
I would add that the client (a friend) fell *** backwards into this job/salary and there is a 0% chance he would be paid similarly on the open market. He essentially runs a gym for some wealthy entrepreneurs and handles other ad-hoc tasks for them. He has no special credentials / qualifications. He would likely have a hard time finding similar work if he ever left the current situation.Originally posted by New York Enrolled Agent View PostComment
-
Sounds like a way for this "old" company to get away from payroll taxes, etc and for your client to pay WAY less taxes is your "think" 50k is reasonable. He was paid $145k from the same company, that would be the reasonable salary plus or minus. What expenses is he writing off if he is running someone elses gym???
Again, sounds like he talked someone into 1099ing him and forming an Scorp so he wouldn't have to pay taxes SS/Med taxes on $145k and find an accountant to take the fall if he gets caught.
ChrisComment
-
I had never heard of this "Kohler matrix" before so had to go looking. It's just some guy who has mocked up an illustrative graph which vaguely tries to tie officer payroll to a percent of net profit. The Y-axis is some kind of weird, semi-logarithmic scale (it's not consistent) and it is not a matrix, it's just a line graph, except it's not a straight line and the bend points appear to be arbitrary. Here is a link to the graph:
He specifically states in the accompanying write-up, "MOST IMPORTANTLY, note that determining the proper payroll for a business owner is not an absolute science. It’s a subjective analysis and this diagram is simply a ‘starting point’ or a ‘guide’ for S-Corporation owners to talk about with their tax professional." So contrary to what was posted in the OP, there is no claim that using this graph results in a "reasonable" compensation number.
Back to the OP: so this guy decided to set up an S-corp instead of the default of simply becoming a sole proprietor. Why should that fact alone (and nothing else) have such a large impact on the tax from his earned income? Anyone care to explain how this is a fair or reasonable application of taxation (yes I know it is the law, it's the law I'm asking about)? One simple solution would be to expand the Medicare tax (2.9%) to all pass-through income from S-corps. This would be less drastic, and easier to understand, than similar recent proposals to expand the NII tax to pass-through income over $400K (see Forbes article here which discussed such proposals and also refutes the many falsehoods propagated about what effect they would have).
And one last comment about the OP situation: does anyone think that this guy is actually maintaing required board meeting minutes and other necessary actions, such as keeping corporate and personal funds completely separate, to prevent piercing the corporate veil?
"You said it, they'll never know the difference. Come on, we'll paint our way out!" - Moe HowardComment
-
RR, instead of new taxes or laws, they could structure more compliance on current laws. It doesn't seem like it would be all that difficult to program the computers that if certain parameters are met then S corp receives a letter about reasonable compensation. It wouldn't even have to propose a change or access a penalty. Just knowing that it is being looked at would be enough to get a lot of people to straighten out. If the same company keeps coming up in parameters for say 3 years, then they get a letter that they need to explain why salary is "reasonable".
No one has said the 50K would be reasonable in the situation, but we both know that tons of returns with similar numbers are filed all the time and the IRS doesn't do jack squat about it.Comment
Comment