S Corporation Audits Coming Soon

[DTS]

Bb

Bart,

David is showing off! Shame on him. : (

Dennis

[veritas]

The IRS

is using old tricks. It's a methodical campaign including verbage on the S-Corp acceptance letter warning about reasonable compensation. What surprises me is the crybabies don't try to slip in some specific legislation. It's pretty amusing they get so worked up about a possible 5 billion in lost revenue while on the other hand the "Gap" is estimated at 350 billion.

It reminds me when social security numbers for dependents were first required to be listed on the 1040. Millions of people dissapeared from the face of the earth the first year. But the service didn't have a mechanism to match social security numbers until later years.

Hopefully it is contested at every level and it gets to expensive for them to pursue.

[S T]

S Corp Losses

What is the viewpoint, where the S Corp has no profit, and the shareholder/s keep infusing money.

How can reasonable wages be paid if no profit in the first few years? However loan payments to shareholder/s are being paid?

Sandy

[Jiggers]

Officer's Wages

What is the viewpoint, where the S Corp has no profit, and the shareholder/s keep infusing money.

How can reasonable wages be paid if no profit in the first few years? However loan payments to shareholder/s are being paid?

Sandy

At a seminar for corporations these questions were brought up.
When there is no profit, write up the corporate minutes indicating such and that $XXX is the salary that should have been paid AND will be paid as soon as the funds are available. This also pre-empts the Unrealistic Salary argument when there are funds available and it appears that the wages are unusually high.

The shareholder is a creditor and has taken money from his investments that were earning investment income. He expects to receive payment for these loans also. Just be sure to document in the corporate minutes.

[JON]

White paper

This all started from the annual report that gives the information collected on the previous year's tax returns. What they discovered was a huge explosion of 1120s starting in the late 1990s. After gathering all the data their conclusions were presented to Congress including saying how much social security would be collected if stockholders, like 1040(Schedule C), would have to pay FICA/MEDI on the salaries plus any net taxable of the corporation. The aruguement was why should there be a punishment for being a Schedule C. Congress did get excitied at the thought of additional revenues for social security. As soon as the 2003 project was to be completed they were supposed to go back to Congress with the results and proposals. It was to be presented in 2006 to Congress. Based on Jennings comments instead of proposing to Congress they are auditing more? I think Congress has been waiting for their proposals and are going to get some. I think auditing more is a suprise as the IRS auditors freely state they do not enjoy auditing for FICA adjustments.

We discussed with the IRS what is reasonable. Of course they said that would depend on facts and circumstances, but did say surveys should be available someplace. In Minnesota they pointed us the Unemployment department which has such surveys. Very good and helpful with small busineses. I have never worried that much about it. There is one client, a barber, that I argue with him that more should be salary, but that is it. The facts and curcumstances are what are the sources does the corporation have that contribute to its earnings. Inventory, services provided by other people and equipment are items that make money. The next step is what if you are a one person tax practice. Does all the income have to be salary. HECK no, the preparer pays HUGE dollars for equipment, software and supplies and he better make profits off of each of those investments or he should not be paying for them. In addition their are those darn intangibles-by then the arguement is getting confusing. I had this arguement with an IRS agent who presented some information to a meeting I was at.

They are after the abusers. If you are not reporting salaries on an S corp where it is the stockholders only source of income you should worry. Under audit you will lose. If you have not had any 941 reporting your loss will be expensive as failure to collect, failure to file and failure to pay and interest will be HUGE.

I think even a bigger problem are those filing 1065s and saying 0 self employment income when members and partners are working for the operations.

[Bees Knees]

The facts and curcumstances are what are the sources does the corporation have that contribute to its earnings. Inventory, services provided by other people and equipment are items that make money. The next step is what if you are a one person tax practice. Does all the income have to be salary. HECK no, the preparer pays HUGE dollars for equipment, software and supplies and he better make profits off of each of those investments or he should not be paying for them. In addition their are those darn intangibles-by then the arguement is getting confusing.

It does not matter how many computers, copiers, or desks you purchase for your business. If you don’t have someone doing the work, the business is not going to make money. No business thinks it can buy inventory to make money but then refuse to pay workers for the first five years because it ran out of profit to pay any wages. You can’t say the business can’t afford to pay wages until it turns a profit, because no worker will agree to work for free, UNLESS, the worker is a shareholder and has ulterior motives in deferring compensation.

That is why the number one issue is what it takes to pay someone else to do the job. Money earned from the assets is a secondary issue. The investment side of any business is always the last that gets paid. It may be that 100% of the profit should be wages to the shareholder in the first few years of operation. Then after the business gets established, you can start saying things like my computer deserves some of the profit as a return on the investment.

[S T]

Thank you

Thanks Jiggers for that information. Brings a slight "sigh" of relief.

Sandy

[JohnH]

Return on Investment is Important

My computer never deserves any profit form my business, but I deserve a return on the money I invested in the business to buy the computer (even if the business makes no profit, even if the business can't afford to pay me a salary, or even if the business earns a healthy profit). If that doesn't make sense, then Warren Buffet is a fool.

[Questionguy101]

I know an interesting case like this: The 100% shareholder of a S-Corp pays himself $0 as wage. But he takes out almost all the profit of the S-corp every year and reports the full amount on a 1099-MIsc which in turns goes to the Schedule C of his individual tax return. He treats himself as an independent contractor who provides services for the S-corp. So he has actually been paying FICA (up to the max) on almost every single dollar of the profits of the S-corp.

Is there a problem here? What might cause him problem in case of an audit?

[S T]

I guess he is making an attempt

I guess he might be trying to comply with paying wages, but shouldn't t/p be issuubg a payroll check and file the appropriate form 941 returns quarterly and of course the appropriate State payroll returns, make the payroll deposits as required and file the appropriate returns. All within the payroll tax deposit and reporting rules.

What is the purpose in issuing a 1099 and paying all at year end? Is he just waiting to see how much profit there is?

Problem might be penalties and interest on not paying quarterly, weekly, semi weekly or semi monthy, etc. or possibly not filing payroll taxes at all.

In your example, at least the t/p seems to be making an atempt!

Other viewpoints would be welcomed.

Sandy

[Black Bart]

I know an interesting case like this: The 100% shareholder of a S-Corp pays himself $0 as wage. But he takes out almost all the profit of the S-corp every year and reports the full amount on a 1099-MIsc which in turns goes to the Schedule C of his individual tax return. He treats himself as an independent contractor who provides services for the S-corp. So he has actually been paying FICA (up to the max) on almost every single dollar of the profits of the S-corp.

Is there a problem here? What might cause him problem in case of an audit?

Not a problem yet, since IRS hasn't picked him out of the hat, but if they ever do, he's probably going to be duck soup for the auditor. Like S T said, he's giving it the old college try by actually paying tax on the whole thing with a 1099, but they probably wouldn't be satisfied with that fig leaf since the client would obviously flunk almost all the form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes...) questions relating to behavioral control, financial control, and relationship of worker/firm. As ST said, accrued non-filing/payment penalties for weekly/quarterly payroll taxes could be an issue and the auditor would have a field day with those stacked-up sums. Too, 940 taxes would be due and if the state unemployment folks were notified, they'd also have a feast going back however many years the statutes would allow.

He's making a try and I don't think he'd be in trouble for misbehavin', but it could sure cost him an arm and a leg. Everything depends, of course, on whether or not he's audited, but I wouldn't feel very comfortable with a big, fat zero sitting on line seven every year.

[BOB W]

I wonder what would happen if line 7 showed a figure equal to the 1099??????

[Jiggers]

1099 vs W-2 for Shareholder/Officer/Employee

I know an interesting case like this: The 100% shareholder of a S-Corp pays himself $0 as wage. But he takes out almost all the profit of the S-corp every year and reports the full amount on a 1099-MIsc which in turns goes to the Schedule C of his individual tax return. He treats himself as an independent contractor who provides services for the S-corp. So he has actually been paying FICA (up to the max) on almost every single dollar of the profits of the S-corp.

Is there a problem here? What might cause him problem in case of an audit?

If he is deducting any expenses on the Schedule C against the 1099 income, those will be disallowed and he would have to deduct them on 2106/Schedule A subject to 2% AGI, if he even itemizes.

The corporation would also have to pay FUTA (940), State Unemployment, plus related penalties and interest. While he may receive a refund on his personal, I doubt if it would offset the additional tax (SS, MED, and matching) plus FUTA, State, and penalties and interest. And the corporation doesn't get tax deductions for penalties so that might add additional income ont he S-Corp K-1.

Just creates a mess. He really should do it correctly.

[Bees Knees]

You cannot be an independent contractor of your own corporation.

TTB, page 5-21 says:

Corporate officer. Any officer of a corporation providing services
for his or her corporation in exchange for compensation is an
employee of the corporation. [IRC §3121(d)(1)]

Even though the corporate officer paid the FICA equivalent in SE tax, it is not FICA. Therefore, IRS would require the corporation to pay both sides of FICA and FUTA. The officer would then have to amend his 1040 to get the SE tax back, assuming the statute of limitations did not expire. In addition, there would be failure to file Forms 941 and 940, failure to withhold, failure to pay penalties, and interest, which could more than double the tax that should have been paid through payroll.

BIG mistake trying to claim you paid all the tax as an independent contractor.

[sea-tax]

Also If that person made a retirement plan contribution to a simple or sep using the Sch c
se income versus the wages form the s-corp you may find you are in a little more hot water than you first thought.