S Corp Employee

[CYN]

I have a client that is a S Corp and the owner is the only shareholder. The 1st two years he showed a loss but in '07 he will finally have a profit. He has not been paying W-2 wages to himself in the past because of the loss however, he is the only one who works in the corp. I am telling him that he needs to be an employee but he doesn't want the hassle. Is it alright to not pay yourself wages if your S Corp has a loss? I know he must start to withhold for himself or he could have more hassle than he wants. How should I handle this.

Thanks,
Cynthia

[Bees Knees]

I am telling him that he needs to be an employee but he doesn't want the hassle.

Then tell him to dissolve his corporation. If he doesn't want the hassle, he should not be an S corporation, as being paid a wage for his work is actually a requirement under code section 3121(d)(1).

If someone came to you and wanted you to do the return, but then told you they didn't want the hassle of keeping records to support their Schedule C deductions, but would rather just pull the numbers off the ceiling, what would you do?

As to your question about paying wages during loss years, since this is an S corporation, IRS isn’t going to squawk if no wages are paid. They are only concerned about trying to pull profits out of an S corporation without the shareholder paying FICA. Once your S corp has a profit, you have to make sure reasonable wages are paid to the shareholder for services rendered. Make that your firm policy, or the client can go someplace else.

[dsi]

CYN,
If your client took any distributions, they could easily be reclassified by theIRS as wages regardless of the loss.

[Luis Mopeo]

Why is there a disconnect between the IRS audits and court cases?

Finding the answer could help solve the puzzle.

The IRS audits S corporations and reclassifies income as wages because the wages must be reasonable. It's no surprise that the definition of "reasonable" has some room for conflicting views.

What is surprising is that you never see a court case where the amounts get anywhere near a real discussion of what "reasonable" means. All the court cases have been where an S corporation pays zero wages, or such a minimal amount it might as well be zero. We've seen all the cases where the S corporation makes a couple hundred grand and wages are zero. Where are the cases where the S corporation makes a couple hundred grand and the wages are $25,000?

With thousands of audits of S corporations, those situations are out there. Why don't they ever land in court? Why do the IRS and the taxpayer always reach a resolution before it gets that far? Is the IRS trying to keep these cases out of court? It would seem to me that it would take about one court case where they turned $25,000 in wages into $100,000 in wages, and there would be a flood of W2 wages being paid to S corporation shareholders instantly.

It doesn't make sense.

[JohnH]

Could be lots of reasons

You make some interesting points, but there could be lots of reasons this never goes to court.

The IRS may not want to go to court because they don't want the risk of turning $25K into $100K in wages and then seeing the court agree with the taxpayer and turn it back to $25K, thus potentially setting a precedent they don't like. The taxpayer might not want to go to court because income tax is a wash and the extra FICA/Med tax on the $75K difference is $11K (not counting penalties, interest, or multiple years). Assume the taxpayer persuades the court to agree on $60K as being resonable rather than $100K - they save about $5K in taxes but how much will the representation fees be, and they will be paid even if the taxpayer loses? The risk of fighting it is fairly high and the potential return not so good.

In this case, both the taxpayer and the IRS would have an incentive to agree to a compromise on $50K - $60K with a promise to increase the amount in future years if business circumstances stay about the same.

And then there's the possibility that the IRS doesn't push the issue very much is because they are really expecting to ultimately get the law changed so that S-corp earnings are subject to S/E tax, which makes all the other discussions about the subject irrelevant.

[Golden Rocket]

Precedent

I think IRS is avoiding safe harbors. I use the term loosely because I believe a "safe harbor" is something actually created by code or regs, and not by the court.

But a court ruling could establish a precedent, and I know from their past behavior that they would rather hold their interpretations of "facts and circumstances" to beat up taxpayers than to be held to finite law or precedent. As to John's post, I haven't heard of anything in pending legislation which attaches SE tax to S Corp profits, but if so, that would make the entire issue a moot point.

If would also eliminate a big reason for selecting a subchapter S. I learned recently there are some 3 million FEINs for subchapter S corps, 2 million FEINs for C corps, and less than 1.5M for Partnerships. [NCPE - don't know where they got this info but it sounds reasonable].

[JohnH]

Article Regarding S-Corps & SE Tax

Here's a link to an article which mentions the concept. It dates back to 2005, but in the broad scheme of things that is fairly recent info:

http://www.microsoft.com/smallbusiness/accountants/articles/change-in-s-corp-tax-treatment.mspx

And here's the Senate Finance Committee Report:

http://finance.senate.gov/hearings/testimony/2005test/rgtestrpt052505.pdf

Not that I agree with any of this, but if I were a slimy politician trying to buiild my campaign on the rhetoric of "soak the rich" and "tax the mean old corporations", what better punching bag would there be than "corporations that beat the government out of Social Security Taxes" that need to be paid into the imaginary "Trust Fund" so that everyone gets their fair share of the booty. Especially when I have Treasury Department employees writing great sound-bites like this for me - "the S corporation form of ownership has become a multibillion dollar employment tax shelter for single-owner businesses" (see page 2 of the report). Just a thought here in this pre-election year...

[ChEAr$]

Back to your original question

I have a client that is a S Corp and the owner is the only shareholder. The 1st two years he showed a loss but in '07 he will finally have a profit. He has not been paying W-2 wages to himself in the past because of the loss however, he is the only one who works in the corp. I am telling him that he needs to be an employee but he doesn't want the hassle. Is it alright to not pay yourself wages if your S Corp has a loss? I know he must start to withhold for himself or he could have more hassle than he wants. How should I handle this.

Thanks,
Cynthia

There's still time this year for him to begin paying himself a salary. in fact time to begin
this month, September. You just have to read him the riot act, as we used to say. Sure,
it's his call, but it's also your call whether or not to send him packing or not.
(need I say more? grin)?

[Matt Sova]

S-Corp wages

If the S-Corp lost money and he did not take a wage that is fine in this case because it was the first 2 years and he did not have any AAA to take distributions against. Remember the law says you have to take a "reasonable wage" and if the business loses money, a reasonable wage is $0.

In 07 he is profitable, how profitable? If he is going to make 5k then a wage of a grand or 2 would be sufficient. Why would any "reasonable" business owner take a wage of 60k to generate a loss of 55k in the business? If it is highly profitable then the wage should be higher.