An LLC Question...

[Matt Sova]

S-Corp SE tax issue

The whole S corp to avoid SE tax issue is a thing of the past. IRS is launching a major audit campaign to nab all you who set up S corps for your clients to pay low wages and high distributions just to avoid SE tax. The courts have already ruled on a number of these cases.

Bees,

Although this is not what this string is about, I have to disagree with the above comment. There are NO court cases where the IRS has tried to convert distributions to wages and won when the S-Corp owner has taken a wage. Where the owners lose is where they have distributions and 0 wages.

The code does not define "reasonable". The courts do not define it either. If a client of mine wants to pay lower SS and Med taxes we use $1000/month. Think about it this way min wage x 40 hrs/wk x 52 wks/yr = $10,712/yr. $1,000/month is greater than min wage - reasonableness is proven.

That being said, I also inform them of the lower contributions to SS as well as retirement plans. I make sure my clients are well educated on the pros and cons of using a low wage. One of the cons, however, is not that the IRS is going to convert distributions to wages.

Matt

[Unregistered]

NY either

don't operate in California or NY. I have an LLC that is headquartered in NC but has two nonresident partners who reside in NY and operate the sales office. we have to file NY and NC and they have to pay the $500 franchise fee to NY even though they do very little in the state. this is where effective planning beforehand with a competent professional can really pay off in the end.

[Bees Knees]

Although this is not what this string is about, I have to disagree with the above comment. There are NO court cases where the IRS has tried to convert distributions to wages and won when the S-Corp owner has taken a wage. Where the owners lose is where they have distributions and 0 wages.

IRS Market Segment Specialization Paper (Veterinary Medicine)

Excessive/Inadequate Compensation

“ In a C corporation, excessive compensation may be paid to
shareholder/employees as a means to avoid paying the second tier tax on
dividends. Because S corporation distributions of earnings are generally
not subject to second-tier tax on dividends, whether a shareholder has
received excessive compensation is generally irrelevant. Indeed, since
only amounts paid as wages are subject to employment taxes, S corporations
have an incentive to distribute earnings as dividends and pay inadequate
compensation to their shareholder/employees.”

The MSSP then goes on the explain the factors deemed relevant in deciding inadequate compensation and that these are the same factors that were used to determine excessive compensation in C corporations. If you read that report, you will note that the IRS is training auditors to go beyond looking for just S corporations with zero wages. They want to see reasonable wages, determined by such factors as:

A) Employee qualifications
B) Nature, extent, and scope of work
C) Employer’s salary scale
D) Industry compensation rates

These are facts that go way beyond the zero wage issue. So although you are correct that we have not yet seen these cases in court, you can be sure we will soon.

[Matt Sova]

Court cases

These are facts that go way beyond the zero wage issue. So although you are correct that we have not yet seen these cases in court, you can be sure we will soon.

Incorrect. There have been court cases in the past. I remember reading about one back in the 90's in CA where the owner of an S-Corp took a wage up to the amount of the CA unemployment limit (cannot remember the dollar amount, but I think it was 9k). Had distributions of something like 100k.

The IRS tried to reclassify the majority of the distributions to wage. The court sided with the taxpayer and deemed that the CA unemployment limit was a reasonable basis to use for the wage.

If you want to be conservative, that is fine. I like to present all sides of the arguments to my clients and let them decide what they want to do.

Matt

[Bees Knees]

Even in the case you cite, you said the court "deemed that the CA unemployment limit was a reasonable basis to use for the wage."

That to me says a number above zero may not have been deemed reasonable.

What is reasonable? $10,000? $20,000? $30,000? $50,000? And why did the court determine the CA unemployment limit was reasonable in that case? Would it be reasonable for every S corp owner? Would the same CA unemployment limit for an executive be the same as for a dishwasher?

[JON]

The 2003 - Book plus the GAO

The IRS releases info on thax years approximately 2 years after the calender year end. It was called the 2004 Data Book - it is for the claendar year 2003. Last year at the request of the legislative branch the GAO investigated and wrote a report on S Corporations. One of the main reasons it was taken up was the growth in S Corps in the late 1990s. There only guess was FICA taxes. The conclusion was WHY should S Corp have the ability to avoid SE taxes when the 1040 Schedule C proprietor is taxed on the entire amount for employment taxes. They quantified the number that the Social Security administration could collect and that got politicians happier. The IRS, in all the papers, expanded the audit of S corps by 5000 as a result of the request. Keep in mind the number of S corps filed in 2003 and the audit % was to be .0026%. By adding 5000 that is another .001484%. The additional audits of 2003 are to examine the S Corp stockholder salaries for reasonableness. Of course that will be arbitrary by the IRS, if they change. If you want to appeal as the preparer you can. DC is broke-Social Security surplus has been loaned out and will never return in total if at all. Politicians will support any method of collecting more. So be ready.

In Minnesota the state Department of Unempolyment's auditing department is 100% paid for by the IRS as long as they audit at least 4% of the filers per year and share the information with them. The report includes a section on S corp shareholders and compensation. The local IRS agents say reasonableness will be based on published surveys and actual results of the review of the company's activities including salaries and distributions in relation to each other and how and when paid. Who knows what sucess if any will they have. As of 2003 the 1120s fomula factor at the IRS compares, computer, compensation verus distributions. It does not take into account stockholders not active in the business.

[Unregistered]

California

Land of the oranges and the nuts.

[DTS]

To Unregistered: Oranges and nuts

It never ceases to amaze me that idiots like you always find time to make comments or generalizations about people or things they know nothing about. Why don't you keep your petty-a$$ comments to yourself!

Dennis

[Matt Sova]

Any court case???

I will concede this issue as soon as you can show me a court case where the owner took a wage (of ANY amount) and lost in court to the IRS. The courts have not and will not quantify what "reasonable" is. Period. End of Story. Plain and simple.

Matt

[Unregistered]

doctor/S-Corp shareholder

Matt,

I have a doctor, an optometrist, who is the sole shareholder of an S-Corp for which he performs personal services 3-4 days a week. We chose to have his pay set at 1/2 of what he would be paid as a 1st year doc at another practice (based upon 1/2 work schedule). Do you propose that we could reduce his pay to $17,300 per year (unemployment wage base for the state of NC), which is about 40% of his current pay, and not raise a red flag. I have discussed this option with him and he wants to do whatever is going to reduce his pay but does not want to raise a red flag. I would like to get your opinion, along with those of others who have similar businesses under their advisement.

[DaveinTexas]

If anyone can explain a LLC to me....

I will do your dirty laundry for 10 years. Of course, I am only kidding, and this is not a binding contract.

Seriously, I know a LLC can choose its type of taxation; corp, sole prop or partnership. A LLC consists of "Members" and corporation, shareholders? But what is the difference between forming a C corporation or forming a LLC that chooses to be taxed as a corporation?

And who would form a LLC and "put real estate into it"? Why would you want any entity, but yourself to own any property?

I hope I didn't confuse anyone with this line of questioning. And remember, it depends on what your definition of "is" is.

[Bees Knees]

I will concede this issue as soon as you can show me a court case where the owner took a wage (of ANY amount) and lost in court to the IRS. The courts have not and will not quantify what "reasonable" is. Period. End of Story. Plain and simple.

Matt

Matt, the courts have quantified reasonable wages for years in the case of C corporations paying too much wage with the dividend issue. Why would you think the courts are not going to do the same to S corps the minute IRS gets their audit act together? Of course there is eventually going to be court cases dealing with this issue. Auditors are being trained on it as we speak. They are warning us to get reasonable. Do you want your clients to be the court test for the rest of us?

[natiro]

choice of entity

Seriously, I know a LLC can choose its type of taxation; corp, sole prop or partnership. A LLC consists of "Members" and corporation, shareholders? But what is the difference between forming a C corporation or forming a LLC that chooses to be taxed as a corporation?

My understanding, from posting this same question on another board last year, is that LLCs have less stringent requirements than corporations do. . .no annual meetings, no board of directors to elect, etc. If you don't fulfill the corporate requirements then you risk the liability protection afforded to you in becoming a corporation. Since the LLC requirements are less stringent, it is easier to retain liability protection even if you elect to be taxed as a corporation.

I may be missing this in the thread but it seems that the original question asked which entity would be best for holding the real estate. In my opinion it is generally best to choose an LLC over a corporation (S-Corp or C-Corp) for holding real estate. An LLC can distribute appreciated real estate to the members without having a deemed sale so no gain is recognized on distribution. The corporation cannot distribute appreciated property without reporting gain on the distribution. I would assume that this would be true for an LLC electing to be taxed as a corporation, too. I've had several corporate clients with real estate holdings inside the corporations who cannot distribute the real estate to new entities without taking big tax hits on the transactions.

[pmedders]

An LLC Question

So would it be best if client lives in California to set up real estate as an LLC under a partnership with his wife or just sole proprietor.

[Unregistered]

RE: Reasonable Comp argument. Which is cheaper? PR taxes or lawyers?