Discussion:Preparer Penalty Issue

New 1120 clients. There are 2 1120 insurance companies. Both owned by same 3 equal shareholders. One is a property/casualty agency and everyone is paid as employee (including shareholders). Second (the problem area) is a life insurance agency. The 3 shareholders are paid as 1099 independent contractors.

Any advice as to how this should be handled? Assume that they will not back down and retroactively change compensation to wages. Is putting the shareholder comp as such on the return enough disclosure to avoid preparer penalties, or do you have to state that they were not treated as employees and bring on the audit police?

They have prepared the return like that for years with no questions being asked. Therefore, they see no reason to change now.

I guess that is the issue. As far as the preparer is concerned I believe full disclosure (via Form 8275) would absolve the preparer from any sanction. After all, the preparer would only be reporting what actually did happen. IRS, in effect, would be put on notice that things aren't quite right.

If the 1120 shows an entry on the Officer's Compensation line, but no taxes deducted (such as would be for payroll taxes) does that constitute adequate disclosure to the IRS that SALARIES were not paid and preclude the use of Form 8275?

First, these are not S Corps. They are C Corps.

The officer/shareholders in the life ins corp are the only persons receiving compensation other than a few independent agents not associated legally to the corp. All of the employees are with the Prop/Casualty insurance corp and only deal with that side of the business.

In other words, the Prop/Casualty corp is not doing the life insurance work and sending the commissions to the life ins corp.

Question then becomes:

What do I need to do in order to avoid any preparer penalties whatsoever in this situation? Flat out disclose to IRS that shareholders are not being treated as employees as I believe them to be? If so, on Form 8275? Form 8275-R as a regulation disclosure?

OR, just continue (as has been done in the past) to show the amounts they were 1099ed for as Officer Compensation on line 12 of 1120? They have also filled in Schedule E with each shareholder's name, ID#, % of time, and compensation amount. There is NOT, however, any deduction on the return for payroll taxes. There have never been any quarterly payroll tax return filings. In short, anyone picking up the return would see an entry for Officer Compensation, BUT, they would not find a payroll tax deduction you would expect when someone is treated as an employee.

Thanks for all the replies. Keep 'em coming!

In other words, if the professional found 2 of 5 cases supported the taxpayer in analagous situations, he would have had substantial authority under old standards, but now under MLT, he does not but the taxpayer would.

I am taking the above from this week's Kiplinger Report.

If true, this sounds a far cry from what is happening here.

Adequate disclosure is whatever IRS says it specifically is, meaning they have to issue at least a Rev. Proc. on given line items. Like they did under 6662 (nee 6661). Else, to me, this proposed disclosure only says to IRS, "We gave you guys enough hint there's a potential issue here."

I really don't see IRS ever proposing a prepare penalty issue here, if the FICA and income tax effects are a wash -- not net tax deficiency. However, returns should be done properly on the basics, namely closely-held corp officer/shareholders can't work independently of their own corp. Disclosure can't ameliorate that under any standard, IMO.

This client was a Sole Prop (Sch C) and he had employees. He paid his employees but did not withhold or pay any payroll taxes. He did not file any payroll forms. The wages were clearly reported on the Sch C. The client was fully informed for the payroll requirements regarding withholding and payroll reporting. What position does that put the preparer in? Wages are fully disclosed, there are no payroll taxes reported on the Sch C. What disclosure is required, if any? The Sch C clearly shows what is going on.

JR - You are right...we're in a position of being cops.

It's not my place to audit a client. Mine is to inform the client of his requirements and point out any defiencies he may have.

http://www.educationfoundation.org/webcast/webcast_display.asp?Par_EventId=87050802&Par_EventYr=07Link title

To get back on point:

1. Is there an "underpayment" here for any penalty to even be assessed? The compensation has been paid and turning it into wages will only decrease the corporate tax.

2. The shareholders have paid all income and self-employment taxes on those payments (with the exception of uncollected FUTA). If translated by IRS as wages, the problem to me would be penalties for undeposited taxes.

JR1-

On audit, they would absolutely prevail as to the deduction itself. IT IS officer comp and it was paid. So the amount is not in question and, as I note above, changing it to wages would actually increase the deduction. (Ignore for this sake the second point I made as to penalties!)

They have apparently been warned about the penalty issue before now. This way of treating their comp seems to have come about in the past due to the fact that each shareholder has been taking their own deductions applicable to earning this income on Schedule C. The simplest way to handle to their way of thinking.

Bottom line, I DO agree that they do not have any reasonable basis to treat this as 1099 comp but the deduction itself is proper as to amount.

They seem to be willing to risk the penalties but I do not want to risk any preparer penalty to myself. Any way to satisfy both requirements?

Thanks to all.

Now why caint you apply the common paymaster rule here? One of you kindly answer yore poor old Aunt Emmy or else shes gonna have the shakin fits all day and have to find old Crow fer some tonic. Dont matter really cause its gittin on time fer tonic anyways.

My understanding was that it was set up originally as a separate corp for 2 purposes:

1. There was another shareholder in the Prop/Cas corp who they did not want to have any claim on the life business they were starting. (he was to shortly leave the prop/cas corp)

2. By joining together in a common entity, they (the insurance salesmen/shareholders) would get a better commission rate from the insurance companies. Since they were used to the corporate form, that is what they picked. I want them out of that form, but that's for next year. I have to deal with last year in some way.

So, to be specific, yes it was done as a gathering entity and each shareholder is compensated equal to the commission he personally earned.

That's true, but a nitpicky way to generate a net due to IRS on the audit. Salt in the wound if the S/Hs made timely ES payments. Can we like get credit against penalty for those? :-) This is why field personnel are not prone to raise this issue, and surely not abusive enough for preparer penalty later after audit closed. Of course, the situation is different if the workers are over FICA on other earnings, so the Corp 1/2 of FICA is being evaded. Knowingly doing that, in a situation where it's clear they are employees, is evasion. It's aiding/abetting for the tax advisor to advise doing it that way, defaulting to preparer penalty if case disposed only civilly.

Before the days of LLCs I'd seen two-three businesses 'combine' resources to set up a health insurance group, but in corporate form. All money going was to pay premium.

My conclusion is that this is a situation where the risk of lack of payroll can be explained, and in reality it would be ridiculous for the sales people to incur the costs of workmen's comp, unemployment insurance and disability if offered in the state.

Gone also is the 1/2 of S/E tax deduction, but that washes on an S Corp, and (washing + or -) on a taxable C Corp, when the employer pays the FICA deficiency -- a timing issue for IRS audit consideration.