Discussion:S Corp-IRS Auditor Claiming all Draws s/b Salary

All the court cases deal with shareholders taking -0- salary. I am looking to see if others have seen a similar approach by the IRS. Also I am looking for any substantiation that can be used to define reasonable salary which the IRS would accept.

[Bureau of Labor Statistics] might be another helpful link

So for example the tax return had an equity amount of 40k @ 10% gave us 4k in dsitributions. But when we figured in a reasonable price for the business it came to say 1 million. Distributions were then 100K.

Nice point.

The fact that they are allowed to DICTATE how much someone should be paid above minimum wage in a corporation is beyond me.

Are they now the new DOL? Are they basically creating a 2 tier form of minimum wage? One for the poor people (who have to work for someone else) and one for the rich (who have their own businesses)?

I just had an agent in here citing DOL laws about a C Corp owners kids working for him. She didn't know her ass from second base and when I HAD to pull the applicable DOL laws, it stated clearly that DOL laws do not apply to parent owned businesses.

The code states reasonable comp must be paid. If this were a C Corp, they would be arguing exccessive salary if you paid out $200,000 to get Corp income to zero.

In short, tell the agent to stick it and go over their head on this one.

Exactly where does it say that?

Seriously, PVV's thoughts are right on but I think I would float such a trial balloon when meeting with her(?) manager. Before that meeting, give your client an idea of the dollars at risk, the cost of fighting vis-a-vis professional fees especially if you take the case to Tax Court, and the possible future advantages of raising salary [expanded SEP deductions, or Solo 401K deductions].

I have had docketed Appellate cases settled on risks of litigation principles where total potential liability is multiplied by that percentage and that figure becomes the total dollar settlement. This works well when you have a great case like this, but where it will cost fees that will far exceed a compromise. In one case, after going over documents, Appeals officer felt Service had 20-25% chance of winning, pointing out the risks of testimony by my client and other witnesses, so we settled $3000 for $600 including the interest. Client had a chip on his shoulder and would have been a loose cannon on the stand.

At this point, Appeals is a long way off, and manager does not consider such risks, but the firm point that you will take case to Appeals may sway that personage to settle, or say 'make me an offer,' The answer to the latter is that you will not bid against yourself so that they should make first proposal.

Prospect took 200k salary, and 200k distribution. We were all over saying the IRS was out of line until we spoke to the prospects accountant to get a complete picture.

And Smokey, as I recall, tho' I haven't visited them in a while, both sites have free sections where you can print out your salary range. Salary.com's got pretty tricky to navigate a while back, so I moved over to Payscale.com, but clients have recently been on both and sent me their range info. (Tho' TxSrv will say that that doesn't matter...)

"If a shareholder-employee of an S corporation provides services to that S corporation, then reasonable compensation (subject to employment taxes) generally needs to be paid in return before any non-wage distributions may be made to that shareholder-employee. Several court cases support the authority of the IRS to reclassify other forms of payments made to the shareholder-employee as a wage expense. See Joly v Comm. 2000-1 USTC 50315 (6th Cir., 2000)."

What I'm getting at is little or no litigation yet (or is there?) where the court "split the baby" on the C Corp comp factors, but in an S Corp case, even though Joly perfunctorily cited those factors.

After FICA max, the issue devolves to Medicare tax, so if IRS is getting the basic FICA (little or no W-2), it can settle, even at Exam level. Unless IRS HQ urges they don't do that except in unique facts, but HQ rarely behaves like that.

If we have a P/T officer, such as Treasurer or Sec'y, it's easily possible to examine the facts and pay only a market wage. However, I seem to recall adverse publicity over Sen. John Edwards and his law firm S Corp, with monster contingent-fee victories. High six figures paid out also as distributions, so only Medicare at issue were the statute open for IRS to do anything. Most P/I lawyers consider all of that rather compensatory, and in a C Corp case it would be untouchable by IRS.

Edwards won BTW.

This will end up in litigation again since Congress apparently can't find its cojones to actually do anything useful other than sniping at each other. And we pay for this. But theories behind reasonable comp should be established in good law. It's just idiotic that anyone can, at their whim, decide that a return of equity should be x and therefore the salary is y. Uhhh, sorry, but lots of folks earn negative returns! For a long time, before they're dumb enough to sell! The Courts have rung in, I thought, fairly loudly and clearly about the factors that go into determining reasonable comp. To ignore that...whoa, that reminds of that sec. that got passed a few years ago where the IRS agents started hiding in the offices, something about to ignore law and/or unnecessarily aggravate the taxpayer was grounds for dismissal. Right now, no hearing. Need to dig out Gear Up book to find the cite. Let's be reasonable and apply the law fairly, all the law. And to everyone! If the IRS would enlist us accountants to help them instead of fighting us, we could make some progress.

Regs. §1.162-7(b)(3); VanderPol v. Comr., 54 T.C.M. 1021, 1026 (1987). See Rapco, Inc. v. Comr., 85 F.3d 950 (2d Cir. 1996)

My point being, as Jeff pointed out, every single one of these S-Corps should be getting an audit notice. This is low hanging fruit. What is the IRS thinking trying to argue that $100K salary and $100K distribution is not reasonable?

Here is a perhaps-dated Wall Street expression. "The bulls make money. The bears make money. The pigs never do." Therefore, please don't be a pig about reasonable S corporation owner salaries. Inadequate S corp owner salaries / reasonable compensation has long been a top IRS priority. Many do not get to enjoy the payroll tax savings they get from being a pig about this.

JR1 is wrong to believe there are no cases on it. There have been many cases for 20+ years. Few are new because IRS either compromises or wins outright once they show responsible people what they already won. IRS lost an early case when there was a $25,000 salary, shown to be reasonable by occupation and employment history, though there was $80,000 of income. This shows Courts will be reasonable with reasonable taxpayers. This and similar case are why I know that those who suggest 60% compensation and 40% (or 50:50) often do clients a disservice. In 2004 VP candidate John Edwards proved this with $360,000 in salary on $27 million of net. Many tax professionals found nothing wrong with this. IRS did not comment or apparently examine the resulting $600,000 saving, compared to sef-employment.

I work hard to get clients maximum tax deductions, but had only one S corp tax exam in many years. The exception came a few years ago, after I wrote clients about an IRS plan for exams of Florida S corp construction companies, with little or no officer salaries. A company earning only $28,000 would not report salaries. It soon had an exam. The one required change: $14,000 of salary for each owner (100% of profit). I appeal most personal exams to the Appeals Division and many to Tax Court. However, the clients agreed that the appeal would cost FAR too much, even if they cut the salary in half.

Despite this exam I often have no officer salary with low income. IRS rarely seems interested in low income S corps and payroll tax return filing costs can exceed the tax. However, there is a $7,000 minimum for businesses not operated from home. In Florida most such businesses get mail or on-site unemployment tax exams. Unless officer salaries are the $7,000 unemployment maximum, examiners assess salaries of 100% of profits. The Florida tax on the $7,000 is often trivial ($189 and we have no personal income tax). However, penalties and interest of $1,200+ per year, plus my exam fee, are expensives. The worst is not knowing you can appeal this until after the federal statute of limitations expires. Unless you do you have social security and medicate on 100% of profits. Due to the late paid state tax, federal unemployment is not .8%, nut 6.2%. Then again add penalies, interest, my fees and your time.

So please don't be a pig (or a miser?) about S corporation officer compansation.

In the case of the above company requiring minimal officer services, there were many other companies that also needed minimal services. In such cases, filing many payroll tax returns could cost more than the tax involved. However, the fastest, easiest and least expensive way around this involves make all the S companies a subsidiary of an S company management company. This lets you defenitely have only one set of payroll tax returns and avoids justifying allocations to many companies.