S Corporation Audits Coming Soon

[Bees Knees]

I mentioned this in another thread. I’m going to expand on it in a poll.

Problem: I just got back from a Bob Jennings Seminar. IRS just completed their S corporation test audit program. Out of 5,000 S corporation audits, all but a handful had increase tax adjustments. Number one on the list was S corporation wages too low. Due to the overwhelming results and increase revenue netted from these audits, IRS says they are about to conduct 80,000 S corporation audits. For those who have been playing the beat the FICA tax game, you are about to have your clients audited.

Solution: Advise our S Corporation clients to start paying reasonable wage to themselves. This poll asks you: What is meant by reasonable wage, according to the courts?

Situation: Your client is a 100% shareholder and sole officer in an S corporation with no other employees. His corporation nets $100,000 per year before paying himself a wage. His corporation is in the general auto repair business. What should the corporation pay him on a W-2 assuming no health insurance or other fringe benefits?

[dsi]

I would suggest it's not that cut & dry. Arguments can be made either direction, and therefore makes this a "facts & circumstances" issue. Congress needs to address this issue, not theIRS.

[JAinNC]

Not enough information .....

Net income per books 100,000. But does he have huge business liabilities that eat up his cash flow? What is the norm salary for his type of work in that area of the country? Does he do this full time and how many hours? Does he also handle his books or does he have an accounting firm handle? Are there loans to shareholder that actually should have been wages?

I don't know what is resonable from IRS's point of view but I do think some of the above would come into play.

Jeannie

[Bees Knees]

Net income per books 100,000. But does he have huge business liabilities that eat up his cash flow? What is the norm salary for his type of work in that area of the country? Does he do this full time and how many hours? Does he also handle his books or does he have an accounting firm handle? Are there loans to shareholder that actually should have been wages?

Its not a trick question. Assume this is a normal client - doesn't do anything else, and his bookkeeping is accurate. Liabilities should not have to be an issue since the cost of a liability (interest) is reflected in net profit. Also, the norm salary for his type of work should not have to be a question, as that is one of the possible answers, if you think that is a relevant factor.

[Bees Knees]

I would suggest it's not that cut & dry. Arguments can be made either direction, and therefore makes this a "facts & circumstances" issue.

Assume this is your client, and he wants you to give him an answer. Your client will not understand what "facts & circumstances" is. You need to be more specific.

[sea-tax]

From what I have heard from others going through these audits right now the IRS will push for either Fica Max or all net profit. This is getting really ugly and there seems to be no end in sight.
One friend I have is going through an audit as we speak and the IRS is telling him in a single shareholder s-corp that provides services they are looking at it like a sch c and they want all profit to be wages. This example is a real estate agent.
Another one I heard of the auditor asked what the single shareholder made in there prior job and said then that is reasonable comp.

From what I hear the IRS is really shooting from the hip and one of these cases should end up in court before to long.

[JohnH]

I answered "Cost to hire an employee to do all the work the shareholder does for his corporation" in the poll, but I don't mind saying that this number should be in the $75K-$90K range. This assumes he is not thinly capitalized - he has a significant equity interest in the business which can be used to jusify a decent ROI. I'd say the salary should tend toward the higher side if he's thinly capitalized, lower if he's heavily invested in the business.

[Bees Knees]

From what I hear the IRS is really shooting from the hip and one of these cases should end up in court before to long.

IRS actually has alot of court case data to go with. There are plenty of court cases out there that have dealt with the reasonable comp issue. Maybe not with S corps that actually have paid some wages, but C corp reasonable comp cases and S corp paying no wage to shareholder court cases have been going on for years. There is one common issue that is brought up in each case, both C corp and S corp.

[Jiggers]

Depends

If this was orginally a Schedule C taxpayer with a net profit of $100,000 and that was reported on Schedule C and Schedule SE, then it would very hard to justify a salary of $12,000 per year and $88,000 in dividends/distribution of profits for converting this to an S-Corporation.

[Bees Knees]

If this was orginally a Schedule C taxpayer with a net profit of $100,000 and that was reported on Schedule C and Schedule SE, then it would very hard to justify a salary of $12,000 per year and $88,000 in dividends/distribution of profits for converting this to an S-Corporation.

$5.85 per hour times 40 hours per week = $234, times 52 weeks per year = $12,168

What if he says he can hire a bunch of high school kids who would rather work on cars than flip burgers at McDonalds, and they turn out to be better mechanics than he is and he could just sit back and bring in the same pre-wage profit that he made as a Schedule C business when he did all the work?

[DTS]

Wages

How is an S-corp with little to no income, but huge infusions of cash to keep it afloat going to be viewed in this situation? Will the IRS see the cash infusions (s/h loans) as a way to pay not only the bills, but reasonable wages, as well?

I feel another headache coming on!

Dennis

[dsi]

I believe theIRS is really getting their tits in a ringer with this issue. That is, whatever they determine is "reasonable" for a C-corp has to be the same for an S-corp. It would be completely unreasonable to do otherwise. IMHO

[Black Bart]

Maybe the outlook's not quite as bleak as it seems.

...IRS says they are about to conduct 80,000 S corporation audits. For those who have been playing the beat the FICA tax game, you are about to have your clients audited.

I just found this quote on the IRS website:

S corporations continue to be the most prevalent type of corporation. For Tax Year 2003, about 61.9 percent of all corporations filed a Form 1120S. The total number of returns filed by S corporations for Tax Year 2003 increased to nearly 3.3 million from nearly 3.2 million reported in Tax Year 2002. S corporations became the most common corporate entity type in 1997.

Eighty thousand's a lot, but out of 3 million, it's still not bad odds.

[geekgirldany]

Is this the 5,000 audits that started in 2005?

http://www.thinkinglike.com/S-Corporation/S-Corporation-Audits-2005.html

The chance of any small business owner having his or her S corporation randomly audited is tiny. About 3 million S-corporation tax returns are filed annually. So, an extra 5,000 audits amounts to a 0.16% audit rate.

[Bees Knees]

The chance of any small business owner having his or her S corporation randomly audited is tiny. About 3 million S-corporation tax returns are filed annually. So, an extra 5,000 audits amounts to a 0.16% audit rate.

Thats an extra 80,000, not 5,000. The 5,000 are already finished. IRS had so much fun doing those, they now want 80,000 more.

And very few random audits are ever done anymore. They will use their computers to pick out 1120S returns with low wages reported on line 7.