Discussion:CPA LICENSE ISSUE WHEN SUB S CLIENT DOESN'T TAKE A SALARY

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Discussion Forum Index --> Advanced Tax Questions --> CPA LICENSE ISSUE WHEN SUB S CLIENT DOESN'T TAKE A SALARY


Discussion Forum Index --> Tax Questions --> CPA LICENSE ISSUE WHEN SUB S CLIENT DOESN'T TAKE A SALARY

Davidlat (talk|edits) said:

9 December 2011
I know it's been discussed many times here the issue of sub s clients taking distributions and not a salary. Please let's not get into that again. We all know the answer to that.

I had a meeting this morning with an IRS agent who informed me that the IRS is going after the licenses of CPA's and EA's whose sub s clients don't take a salary. She is telling me it's their position that taking a salary is the law. According to this agent if you sign a return that doesn't show a salary, only distributions, you are signing a false return.

Has anyone else run into this on exam?

Jdanielle (talk|edits) said:

9 December 2011
Last I checked, I don't have the authority to make my clients take a salary. I can advise them on the law and the consequences of not following the law, but it is my responsibility to correctly report their income & expenses. If their books don't show salary paid, then the return won't show any wages. If the return correctly doesn't show a salary how can it be a false return? If I put a salary on the return that wasn't paid as a salary then it is a false return.

Just my two cents

RoyDaleOne (talk|edits) said:

9 December 2011
Agree: two more pennies.

Davidlat (talk|edits) said:

9 December 2011
I agree with you J. Not sure how we can force our clients to take a salary. She is telling me that one CPA in Michigan has already lost his license over this issue. I was just wondering if anyone else has experience with IRS on this.

Actionbsns (talk|edits) said:

9 December 2011
Just wondering, does that Michigan CPA have a name and address? Or is he possibly related to the same kid who finds needles in his Halloween candy every year? There's already an awful lot of fear being generated over the letters and visits from IRS and what that impact is going to be to tax preparers. I truly hope this is just one more rumor to add to the mix.

Captcook (talk|edits) said:

9 December 2011
Taking a salary may be the law, but it does not affect the reporting position. For example, if I have a client who chooses to pay an employee as an independent contractor and prepares a 1099 for that individual, I will not deduct payroll taxes paid because my client did not pay payroll taxes (even though that is the law). I'm not signing a false return. If I prepared the 1099, that is a different issue. If the IRS audits this client and assesses payroll taxes, penalties, and interest on what should have been wages and the client pays them, I will report them consistent with the accounting method of my client and, again, not be signing a false return.

My point is...the client may break the law, but that doesn't mean you should report what the client SHOULD have done. You report what ACTUALLY happened.

Joanmcq (talk|edits) said:

9 December 2011
And document, document, document, your attempt(s) to make the client follow the law. And if the client won't, I would seriously reconsider keeping that client.

Ckenefick (talk|edits) said:

9 December 2011
Here's something I posted on a prior thread:

And don't forget that a "tax return preparer" is no longer just an "income tax return preparer." The new rules apply to all sorts of returns, including 941's. Here's some somewhat related food for thought: You prepare a 941 for an S-corp client owned 100% by Mr. X. There's a slew of Shareholder Distributions during the quarter to Mr. X, but no payroll is actually paid. What are the potential ramifications to you, as the "tax return preparer," if the IRS comes in and says, "Nope, sorry, all those Distributions were taxable wages."

Rkrcpa1 (talk|edits) said:

9 December 2011
If the taxpayer classifies a payment as a distribution, I think you report it as a distribution. I also believe you have a responsibility to advise the client on the rules for taking a salary as an employee. But, I can't force the client to pay salary. Just make sure you have documented that you advised the client in the proper way to handle things. As others have stated, the preparer does not have the authority to make those decisions or to change them. I don't think the fact that you are preparing a 941 changes anything, you report the wages paid, not what you wish they paid.

Ckenefick (talk|edits) said:

9 December 2011
I think

I also believe I don't think

But what exactly do the preparer penalty rules say?

JR1 (talk|edits) said:

December 9, 2011
Better wrap your head around this comment by Karen Hawkins, Director, Office of Professional Responsibility! "Our goal is to make every preparer a mini IRS agent..." at an Arizona meet of accounting pros. She was loudly booed, but went on undeterred. The compliance push that the gov is placing upon US is incomprehensible and reprehensible as well, requiring us to police the taxpayers (their job!), forcing us by brute force to abandon our responsibility as the advocate for the taxpayer. And now that they have your PTIN and have discovered how to use computers, it's pretty easy to search your entire client base for anything a bit off-center of their averages, and then pull returns for audit, fishing. Horror if they actually land a fish, jeopardizing your entire client base.

Yeah, I know. Another sip of coffee? Or Pepto Bismol? Or call my attorney? It's past crazy.

RoyDaleOne (talk|edits) said:

9 December 2011
JR1 the only problem I have with what Ms. Hawkins said is that the use of a professional should be mandatory for everyone, no self filing, otherwise I have a big problem.

JR1 (talk|edits) said:

December 9, 2011
Well, that would be unconstitutional wouldn't it? Wouldn't it??? Oh, that's right, they're requiring everyone to have health insurance, so what the heck?

TTMM (talk|edits) said:

10 December 2011
I do not doubt that the IRS wants to take the position that we are that tax police and should make people do things. How do I make a client do something? Send them to their room until they agree to be good boys and girls? Sit them in the corner? Take away their candy?

Arizona is not the place to be telling someone to do something they don't want to. See NFL and Martin Luther King holiday circa 1990. See the justice department vs Jan Brewer and HB 1070. We passed a law that we ain't gonna have no Obama Care. Ain't no way (just some fly over country sarcasm).

Fsteincpa (talk|edits) said:

10 December 2011
NY has just passed a resolution that they are allowed to require individuals who self file with a tax program to pay any amounts due via electronic payment.

All they did was authorize the commissioner to be able to make this mandatory. It was mandatory for corporations last year if they self filed.

WEISSEA (talk|edits) said:

10 December 2011
"According to this agent if you sign a return that doesn't show salary only distributions you are signing a false return."

Was there any more details, example, there must be a positive number on 1120-S line 7( officer compensation) regardless of net profit or loss?

Podolin (talk|edits) said:

10 December 2011
Signing a "false" return is a pretty strong accusation by any IRS employee. At such time as the tax law becomes 100% clear with no room for opposing positions on the same item or transaction, they can talk about false returns. Making a preparer a "mini IRS agent" puts that preparer in a ridiculous conflict-of-interest position. Getting the word out to taxpayers that preparers are IRS agents will substantially reduce the number of taxpayers who use preparers. What IRS needs to do is limit their threats to what is in the law and regulations, such as reasonable basis, substantial authority, and the Circular 230 requirements. Has anyone looked at the question of whether penalties (taxpayer or preparer) would apply in a case where an S corp. s/h took all the earnings as distributions? I share JR1's outrage.

RoyDaleOne (talk|edits) said:

10 December 2011
Still Ckenefick didn't answer his own question from his knowledge about preparer penalties, I ask him to now do so.

I now believe there is danger in the no officer compensation for an S Corporation paid preparer.

Davidlat (talk|edits) said:

10 December 2011
I will be out of the office until Wed at a seminar. I will call the agent to try and clarify what she says the IRS position is on this. Her position the other day was that a salary is required by law. If we prepare a return with no salary only showing distributions we are helping the client break the law. We are preparing a false return according to her. She claims the IRS is now going after licenses over this issue.

I don't agree with her at all. I was just trying to see if anyone else has come across this on a audit.

Ckenefick (talk|edits) said:

10 December 2011
Still Ckenefick didn't answer his own question from his knowledge about preparer penalties, I ask him to now do so.

Some commentators do believe that the IRS could take the scary and aggressive position that the accountant is helping the taxpayer break the law. That is, as Davidlat mentions above:

If we prepare a return with no salary only showing distributions we are helping the client break the law. We are preparing a false return according to her.

Now, is this IRS position reasonable? Somewhat. But is it completely reasonable? I don't think so. And I also think the accountant's argument is reasonable also - Accountant says: I didn't advise client to take less-than-market salary. In fact, I advised him to do otherwise. I'm only reporting history here on this tax return - I'm only reporting what actually happened. Accountant might also argue that we issued the shareholder a 1099, in good faith, and shareholder picked up the 1099 on his 1040 as S/E income.

And doesn't it also seem that the only way for the accountant to completely comply with what the IRS believes is accurate would be to file (or amend) back payroll reports and reclass some or all of the distributions to taxable payroll. So the question becomes: Is this the accountant's duty - to change history and undo what client already did - or is this the IRS' job?

Thinking this through, let's say payroll is paid in the amount of $75,000, but "reasonable salary" is $85,000 - Have we still prepared a "fale return" as Davidlat puts it? Where do we draw the line? And, another argument accountant could make is that Congress could fix all this by making S-corp pass-thru income subject to S/E tax. And until that happens, we are left with no real guidance.

The long and short is how the preparer penalties are interpreted - Is the accountant aiding and abetting or is the accountant just a historian, only charged with the task of reporting what happened?

Those of you who think the IRS is 100% completely off base here and the accountant has a slam dunk winning argument, might want to think again.

WEISSEA (talk|edits) said:

10 December 2011
From what you have said, my guess is that the law here is IRC 3121(d) and Reg 31.3121(d)-1(b) which defines an employee as any officer of a corporation with one exception for an officer who performs no or only minor services.

The issue then is reasonable compensation for the working officer which there have been several court cases that look into a combination of many factors. The IRS has had a NRP on S corp's and is cracking down on abuses to reasonable compensation. Example, S corp doctor who provides 100% of the company's services takes $200K in dividends but no W-2. I can see a possible penalty in this example. The IRS will argue in a pure services company with no other employees all the net profit should be salary and no dividends. However, in a manufacturing or product based company where services are only part of the profit its a matter of what would you pay a 3rd party to do the job based on industry wages for that job. I will be interested in further details.

CrowJD (talk|edits) said:

10 December 2011
What the IRS is saying is that you would have to turn down the engagement unless the client went back and corrected everything (assuming of course that this lady is correct). So you could be a historian if the client corrected the history, otherwise you couldn't take the engagement.

Podolin (talk|edits) said:

10 December 2011
OK, so let's try a hypothetical. Suppose IRS takes a "reasonable" approach here, in the sense that they only get tough on abusive situations, like maybe the WEISSEA example of a doctor who does all the work and takes zero salary. Then, exactly how should a professional tax preparer/adviser handle other situations that require judgment and interpretation? Suppose there is an expenditure that could arguably be a repair/maintenance but also could be an improvement? There are hundreds more one could come up with where tax treatment is not clear, but might be to an IRS agent. A review of some TA threads would show many of these. How on earth is the professional to discharge the duty to advocate for the client within the limits of the law, but to help the so-called tax system work as it is intended, all the while protecting his/her credentials and licenses? Slippery slope, I'd say, if IRS continues down this path.

Also, specifically as to the no-salary situation posed above, assume a cash-basis S corp. that paid no salary, the year has ended, the preparer learns the facts when it is too late to change what happened, there has been no w/h, etc. Does the preparer now say, "Sorry, you poor fish, you are on your own. I cannot help you without being penalized and/or defrocked"?

Actionbsns (talk|edits) said:

10 December 2011
There also needs to be better information available as to what constitutes "reasonable salary". So often the response to my question, "Well what would you have to pay someone to do the job that you do? That's reasonable salary." will be, "If I had to pay someone to do my job, I'd have to close the doors." I suppose if this is actually true, then reasonable salary for that client is the entire bottom line, with zero income to the S corp. But client's have been led to believe that being an S corp is going to result in mountains of income not subject to SE tax and they are dissappointed to find that's not really true.

Ckenefick (talk|edits) said:

10 December 2011
Also, specifically as to the no-salary situation posed above, assume a cash-basis S corp. that paid no salary, the year has ended, the preparer learns the facts when it is too late to change what happened, there has been no w/h, etc. Does the preparer now say, "Sorry, you poor fish, you are on your own. I cannot help you without being penalized and/or defrocked"?

No. See Crow's comments above - IRS's position is that it's not too late to change things - simply go back and file (or amend) the 941's, etc.

JR1 (talk|edits) said:

December 10, 2011
I would suggest that dropping the 'false return' charge would have a pretty short shelf life. You are indeed, as Chris points out, filing exactly what happened. That cannot possibly be false, ever. It's perhaps not what SHOULD have happened, but is what happened. So to the extent that you did not advise the client to be stupid or greedy, but they were anyway, what are we to do? Indeed, creating a 1099 to mitigate the problem is much closer to creating a false return! even tho' it gets us closer to the right answer.

I'm afraid that some preparer is going to end up in court over this stuff to set some precedence if IRS continues these tactics. We do NOT work for them until they send us money.

Podolin (talk|edits) said:

10 December 2011
I saw that comment. But, especially on cash basis but maybe even accrual, how do you change 941s etc.? Suppose it is summer of 2012 and client asks for your help. Can shareholder's 1040 show withholding and FICA even if, during 2011, it did not occur? How do you change facts? As distinguished from interpretations? Is the 941, in effect, retroactive? Do penalties come into play here? On the 941? On the 1040? States and cities might also get involved in these issues. I must be over-(or under-?) thinking this.

Ckenefick (talk|edits) said:

10 December 2011
Podolin - I undertand your question now. You would just have unpaid payroll tax liabilties at year-end - be it cash or accrual.

Spell Czech (talk|edits) said:

10 December 2011
@ WEISSEA .. When you write "Example, S corp doctor who provides 100% of the company's services takes $200K in dividends but no W-2. I can see a possible penalty in this example" (1) what would the penalty be for, and (2) on whom would it be imposed?

Will CPA (talk|edits) said:

10 December 2011
Does IRS even have the knowledge or authority to start telling the S-corporation owners how much they have to pay themselves, because there are fine limits to the scope of IRS's authority.

So is IRS ordering all S-Corporations to pay their owners reasonable compensation, if that's so then isn't IRS supposed to publish some guidance as to what's reasonable and provide applicable criteria.

Spell Czech (talk|edits) said:

10 December 2011
"...isn't IRS supposed to publish some guidance as to what's reasonable and provide applicable criteria[?]" That would seem so reasonable, now wouldn't it...?

JR1 (talk|edits) said:

December 10, 2011
Well, they'd have to first agree to abide by case law, and that's always a sticky wicket, isn't it? They refuse to do so on the repairs vs. capital improvement issue, and have only recently even acknowledged that comparable salaries have a part to play in determining reasonable salary! Indeed, one IRS auditor recently said that if you keep salary/distributions around 50/50 they'd be ok with that! Great, now add to the stupid factor for those who believe in ratios, which NO basis in law. And of course, they will always compromise for higher income folks if you agree to pay the SS ceiling. But that doesn't help the bulk of our clients, nor does it even resolve the problem of whether the SS ceiling is remotely reasonable even if you earn a good buck.

Death&Taxes (talk|edits) said:

10 December 2011
"False return"????? How can I file a false return is the taxpayer provides accurate records and my return ties into those records, with every $$$$ taken in and spent reflected? Mr. Shareholder called every check written to himself a 'distribution' and that is what I reported, so how can the return be 'false?' It gives every number that will lead you to an adjustment, if you so choose.


By the way, how do I elect to contribute to my IRS 401K?

Death&Taxes (talk|edits) said:

10 December 2011
By the way, Davidlat, more than fifteen years ago on an audit, I told the examiner to 'work harder,' at which point he opened a desk drawer, pulled out a piece of paper and said it was a letter from the then 'District Director' instructing Service personnel to audit all my clients.

That was just before the Roth hearings. One bromide that made its way around at that time was that Service personnel could say anything to you as long as they weren't seated at their desk for then it was an unofficial interview, but when at their desk they had to make a record of every interview.

WEISSEA (talk|edits) said:

10 December 2011
@ WEISSEA .. When you write "Example, S corp doctor who provides 100% of the company's services takes $200K in dividends but no W-2. I can see a possible penalty in this example" (1) what would the penalty be for, and (2) on whom would it be imposed?

When the IRS prevails, it will recharacterize the S corp "dividend" distributions as wages and both the S corp and employee shareholder will be subject to payroll taxes as well as penalties and interest for underpayment and failure to file employement tax returns.

A preparer penalty under 6694 could also be applied for understatements due to unrealistic position( 6694(a) penalty is greater of $1000 or 50% of income derived by the taxpayer) or recless conduct ( 6694(b) penalty is greater of $5000 or 50% of preparer income derived). The OP of this thread is saying the IRS maybe expanding the preparer penalty to disbarment for signing what they consider a "false" return.

WEISSEA (talk|edits) said:

10 December 2011
"greater of $1000 or 50% of income derived by the taxpayer" really meant income dervided by preparer.

Podolin (talk|edits) said:

11 December 2011
D&T, you asked '"False return"????? How can I file a false return is the taxpayer provides accurate records and my return ties into those records, with every $$$$ taken in and spent reflected? Mr. Shareholder called every check written to himself a 'distribution' and that is what I reported, so how can the return be 'false?' It gives every number that will lead you to an adjustment, if you so choose.' Well, D&T, I don't necessarily analogize this to the S corp with no compensation, only distributions, BUT don't you think it would be a false return if a client expensed, say, purchase of land and buildings? His records and your prepared return might agree, but they might still be false. To me, the difference is that the S corp. salary issue is not black and white, whereas expensing real estate acquisitions is. Will CPA and Spell Czech allude to the absence of guidance in the S corp. compensation area, but if and when such guidance is published, assuming it is a reasonable interpretation of the law, the IRS might be in a better spot to assert false return. However, it is not that simple. Don't we still have arguments about reasonable compensation in closely-held c corps.? Yet, I am not aware that IRS is asserting false returns when they win adjustments in that area. I think they are looking at/for the extremes, such as a high-earning S corp., all attributable to one person, and no compensation paid. I think the question is still open on that one (as to false return), but it surely is not good tax policy administration to suddenly start asserting false returns without some guidance.

Death&Taxes (talk|edits) said:

11 December 2011
Do you think John Edwards filed a false return with the salary he took? http://www.rothcpa.com/archives/000873.php
 I did not think far enough ahead regarding a client deducting a building and land as office expense, but if I carry my thought far enough, if all the numbers are there, the return is not false.  Unrealistic position!!!  Definitely, but false, which is the opposite of true.....that is another matter. "True but erroneous" would be my description.  Put this way: the numbers are true but unrealistic, and in the case of a expensed building, the preparer should be penalized, and if this is found a pattern in his returns, his license taken.

Harry Boscoe (talk|edits) said:

11 December 2011
Is "false return" another name for a return that is found to contain an "unrealistic position"? Is "false return" even a widely accepted term?

I've never explored this area because I've never considered the possibility that it would apply to me.

Podolin (talk|edits) said:

11 December 2011
Yesterday, I did a very "surface, casual" search for "false return" and, interestingly, it mostly produced flagrant abuses by PREPARERS, such as those who phony up dependents, steal IDs, fake EITCs, and the like. There are, of course, a number of tax fraud cases, usually criminal, not civil, that use the term. I did not save or copy the research, and I do not maintain it was thorough, but the general flavor was the term applies to very serious, usually criminal, abuses. Like Harry Boscoe, I've never considered that it would apply to me and, happily, over a 40+-year career, never has to any of my clients, either.

RoyDaleOne (talk|edits) said:

11 December 2011
A "false return" is a return with $1.00 of omitted income or $1.00 of unallowed deductions.

Now, I know what you think it is an fact for the jury to decide, however, you need to check some court cases before you just disagree for what has been decided.

Also, look for the definition of material or materiality being an issue.

"Any person who willfully makes and subscribes a false return, statement, or other document, that is verified under penalty of perjury and which the taxpayer does not actually believe to be true and correct as to every material matter, is guilty of a felony. Code Section 7206(1)."

Code Section 7207

"Any person who willfully delivers or discloses to the Secretary any list, return, account, statement, or other document, known by him to be fraudulent or to be false as to any material matter, shall be fined not more than $10,000 ($50,000 in the case of a corporation), or imprisoned not more than 1 year, or both."

Podolin (talk|edits) said:

11 December 2011
7207 is, of course, a criminal statute, requiring all the rights of a criminal defendant under the Constitution. So, the $1.00 referred to by RoyDaleOne is absolutely correct, but rather unlikely ever to be a basis for a criminal prosecution. Back to the OP, I think the S corp./salary issue is much more likely to be subject to the assertion of possible civil penalties on taxpayer and/or preparer, if any. Also, as others above have said, is it really false to report distributions and not salary if that is what the client did?

Podolin (talk|edits) said:

11 December 2011
Same as to 7206.

RoyDaleOne (talk|edits) said:

11 December 2011
Source, except for my comments the sources of this information is from the Internal Revenue Code, its Regulations and Circular 230, all published by United States of America.

Now:

(2) DISREGARD OF RULES OR REGULATIONS. The term DISREGARD includes any careless, reckless or intentional disregard of rules or regulations. The term "rules or regulations" includes the provisions of the Internal Revenue Code, temporary or final Treasury regulations issued under the Code, and revenue rulings or notices (other than notices of proposed rulemaking) issued by the Internal Revenue Service and published in the Internal Revenue Bulletin. A disregard of rules or regulations is "careless" if the taxpayer does not exercise reasonable diligence to determine the correctness of a return position that is contrary to the rule or regulation. A disregard is "reckless" if the taxpayer makes little or no effort to determine whether a rule or regulation exists, under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable person would observe. A disregard is "intentional" if the taxpayer knows of the rule or regulation that is disregarded. Nevertheless, a taxpayer who takes a position (other than with respect to a reportable transaction, as defined in section 1.6011-4(b) or section 1.6011-4T(b), as applicable) contrary to a revenue ruling or notice has not disregarded the ruling or notice if the contrary position has a realistic possibility of being sustained on its merits.

SECTION 10.21 KNOWLEDGE OF CLIENT'S OMISSION.

A practitioner who, having been retained by a client with respect to a matter administered by the Internal Revenue Service, knows that the client has not complied with the revenue laws of the United States or has made an error in or omission from any return, document, affidavit, or other paper which the client submitted or executed under the revenue laws of the United States, must advise the client promptly of the fact of such noncompliance, error, or omission. The practitioner must advise the client of the consequences as provided under the Code and regulations of such noncompliance, error, or omission.

(c) ADVISING CLIENTS ON POTENTIAL PENALTIES--

    (1) A practitioner must inform a client of any penalties that are 
    reasonably likely to apply to the client with respect to-- 
 
         (i) A position taken on a tax return if-- 
 
              (A) The practitioner advised the client with respect to the 
              position; or 
 
              (B) The practitioner prepared or signed the tax return; and 
 
         (ii) Any document, affidavit or other paper submitted to the 
         Internal Revenue Service. 
 
    (2) The practitioner also must inform the client of any opportunity 
    to avoid any such penalties by disclosure, if relevant, and of the 
    requirements for adequate disclosure. 
 
    (3) This paragraph (c) applies even if the practitioner is not 
    subject to a penalty under the Internal Revenue Code with respect to 
    the position or with respect to the document, affidavit or other 
    paper submitted. 


(d) RELYING ON INFORMATION FURNISHED BY CLIENTS. A practitioner advising a client to take a position on a tax return, document, affidavit or other paper submitted to the Internal Revenue Service, or preparing or signing a tax return as a preparer, generally may rely in good faith without verification upon information furnished by the client. The practitioner may not, however, ignore the implications of information furnished to, or actually known by, the practitioner, and must make reasonable inquiries if the information as furnished appears to be incorrect, inconsistent with an important fact or another factual assumption, or incomplete.


Practitioner:

1. Knows (or should have known) of noncompliance with revenue laws of the US. 2. Must inform client of the potential penalties 3. May not ignore implications of information furnished 4. Disclose the position with the return


The IRS now have you telling your client the correct position relevant to S Corporation officer's reasonable compensation, by your own documentation. The client does not correct situation. You now prepare the S Corporation return with that foreknowledge. No disclosure is included about the misclassification of officer's salaries as distributions. Hope you also are not engaged to prepare the payroll tax returns. In addition, the IRS is looking at three years of the same facts.

You now have, repeatedly, willfully made false returns, and willfully delivered false returns to the Secretary, and knowingly, or should have known, you were doing such acts.

Criminal aside, the IRS could impose paid preparer penalties under this facts very easily, because the elements of the deed are right there.

Podolin (talk|edits) said:

11 December 2011
Agree, as long as you say "criminal aside".

Michaelstar (talk|edits) said:

11 December 2011
This has been an interesting read to say the least. One of the issues with S-Corps not yet brought up in this post is: S-Corp "distributions" classified as "loans" on the books and then later in a subsequent year reported as salary.

Now we all realize that at least a "reasonable" amount of those distributions probably should have been treated and reported as salary - but they were not - t/p brings in the work on 02/28 for an extension. We again discuss with the client the issues and the client "listens" and again wants all distributions treated as "loans". This is a hypothetical that I have created (and yes seen - not in my practice) but do you all feel the "tax professional" is in the same quandary based on the tone of this post and the position being taken by the agent as reported by the OP?

Death&Taxes (talk|edits) said:

11 December 2011
"In the old days" clients would report that they had foolishly attempted to deal with IRS themselves. I still recall a woman who walked into Collection in Philadelphia or Camden and was told by the R.O. that she would not eat, sleep or s__t until this debt was settled was paid. She did note he was standing as he told her that; he asked her to sit down but by now she was crying, telling him she was going to see either an attorney or the guy who did her taxes. So we would take a POA, fax it to him and call him and find Mr. Sweetness and Light, once we told him we would submit a 433-A etc etc to see about a payment agreement.

Now it seems we are the ones being told we will not eat, sleep or s__t, along with the client. Gone seems to be the respect Service personnel at higher echelons had for us, or am I overdramatizing this.

The irony is that in a few years the OP's agent will be on the other side of the fence, working for clients.

Podolin (talk|edits) said:

11 December 2011
Being paid by clients, but, apparently, working for IRS??

MWPXYZ (talk|edits) said:

11 December 2011
The "jurat" says we sign returns that are true; I wonder if that is possible.

Does the IRS have the ability to determine a return that is "true". After all, it seems, that once one gets to Appeals, an Appeals officer figures out how much of a cut they can take and still avoid potential litigation). Resolution does not seem to focus on the creation of a "true" return.

Maybe it still occurs, but a magazine used to provide 50 preparers with data and ask 50 preparers to prepare a return, which produced about 50 different tax liabilities. I figure one preparer could come up with 50 versions base on the same information, at least for a business return. And our input during the year probably helps increase the diversity of outcomes.

If we became employees of our clients, tasked with preparing a return and offering tax advice, would we still have as much liability? Either from the IRS or from disappointed clients?

RoyDaleOne (talk|edits) said:

11 December 2011
Michaelstar, the amounts available for reclassification as S Corporation officer salary includes informal loans, and other items such as the value of the personal use of corporate assets (think car), or personal expenses treated as nondeductible expenses. By the way if there are amounts available for reclassification it does not matter if the S Corporation has a loss or not, because losing companies still need to pay their employees.

D&T the old days are gone. For example in the middle of one of the worst real estate collapses in history the IRS decides that it will target rental real estate properties for audit.

I guess MWPXYZ was just musing.

Death&Taxes (talk|edits) said:

12 December 2011
But MPW is right, or was right. Appeals was the place where they would literally play Solomon and split the baby. Or in a docketed case of mine, the AO said to me, 'I feel you have an 80% chance of winning and we a 20% chance but you never know what might happen.' So we settled for 20% of a 5K assessment.....legal fee would have been far more than that. Did that mean my return was 80% correct and 20% false?

RoyDaleOne (talk|edits) said:

12 December 2011
D&T and MPWXYZ you are referring to debatable issues, the S Corporate salary issue is no longer debatable, it is you lose, period.

Podolin (talk|edits) said:

12 December 2011
"D&T and MPWXYZ you are referring to debatable issues, the S Corporate salary issue is no longer debatable, it is you lose, period." RoyDaleOne, are you saying there is no longer a debate as to the AMOUNT of salary, or the FACT that there must be some salary?

"By the way if there are amounts available for reclassification it does not matter if the S Corporation has a loss or not, because losing companies still need to pay their employees." RoyDaleOne, isn't it fairly common for employees to take reduced or even zero salary in bad times in order to help their company survive and thrive in better times, when they hope to get a big salary? Can that argument prevail in the right facts?

RoyDaleOne (talk|edits) said:

12 December 2011
Answer:

The fact there must be some salary. Also, it can not exceed the amount available for reclassification, or reasonable compensation.

Answer:

Help in bad times, that I agree with, however, the corporation had funds available for such amounts that qualify for reclassification.

What is the point to the nick-picking questions. Does it seem I am stupid or something?

Podolin (talk|edits) said:

12 December 2011
Hardly. I am trying to learn from you.

RoyDaleOne (talk|edits) said:

12 December 2011
Old dogs like us need alot of help. lol

Death&Taxes (talk|edits) said:

12 December 2011
Going back to the original question, how can IRS take away a CPA license that they did not give? It sounds to me like she was trying to bully someone.

Mikex2e7n5 (talk|edits) said:

12 December 2011
My source inside the IRS says that all she is aware of is proposing the preparer penalty. Maybe if a CPA has a lot of penalties assessed and keeps on advising clients to take distributions rather than salary might they bar the CPA from practicing before the IRS.

Death&Taxes (talk|edits) said:

12 December 2011
Thanks for that thought: CPA licenses and rights to practice before IRS are different kettles of fish.

Birdman (talk|edits) said:

12 December 2011
I know of a state accountancy board that disciplined a CPA for this issue. Although there were a couple other issues, the non-wage seemed to be the main one. The board suspended his license for a period of time - 60 or 90 days.

Not fair in my opinion. Considering how difficult this job can be and for an average wage, there is too much risk in this profession. I will encourage my kids to have a different career for sure. I was warned when I young, but thought I knew better.

Captcook (talk|edits) said:

12 December 2011
Could you provide a link to this case?

Natalie (talk|edits) said:

December 12, 2011
. . . and keeps on advising clients to take distributions rather than salary . . . It sounds like this is not the case most of the time. I think most preparers posting here would agree that they tell their clients to take a "reasonable" salary (or would if the client consulted them before the year closed).

RobV (talk|edits) said:

12 December 2011
This happens all the time. Client brings in S-corp books in March, no office comp and return needs to be completed. We do Directors Fee for reasonable comp and report it on line 21 of 1040. It has been audited in past IRS does not like it but what can they do FICA has been paid on 1040.

What is the big issue?

Kevinh5 (talk|edits) said:

12 December 2011
Rob, how do you come up with the number to call 'director's Fee'? How do you know the number is 'reasonable'? Do the client's books reflect this expense as described?

Captcook (talk|edits) said:

12 December 2011
"what can they do FICA has been paid on 1040"?

Easy...they can reclass the amount you deemed reasonable compensation and levy penalties and interest on the unpaid payroll taxes at the corp level. By reporting in this way, you have no argument to the negative. You have pegged the amount "should have been paid" as salary and all the IRS has to do is collect the penalties. I did this once. It was not audited, but I was happy to see the SOL run on that return. I will not do it again.

Ckenefick (talk|edits) said:

12 December 2011
What is the big issue?

Honestly, I don't think the way you're doing it is a big issue at all. The guy's paying FICA on the income, right? And to me, this is a reasonable way to fix things. The alternative is filing a bunch of payroll reports...and paying a bunch of penalties. But, of course, this is exactly what the IRS wants us to do.

RobV (talk|edits) said:

12 December 2011
That’s for you and your client to decide. However you want to word it commissions, director’s fee, whatever, it goes on the officer comp line and they pay FICA tax on it on the 1040 return. Sure it goes in the P&L, the offsetting entry is an officer loan account. If there is cash they take it out and zero out the account. If there is no cash they already took out the cash, and you just offset the loan or reduce the dist acct.

You decide on the comp just like you would for any other client. We do not have any hard and fast formula. It does happen all the time though, non-filers come in haven't filed S-corp. returns or 1040 for multiple years. You do the books and you comp out the owner for some reasonable amount. It has to be done, we would never think of completing an S-corp. return W/O some officer comp. If business income is 20K, I would do 7-10 K as officer comp, depending on weather it is a service business or what, it all depends on the facts and circumstances.

Kevinh5 (talk|edits) said:

12 December 2011
Rob, I hardly think that $7,000 is a reasonable salary to pay for a full-year employee. Especially if the company made more profit than that. Is that even minimum wage?

You're not concerned with preparer penalties for pulling a number out of the air? Or having your client cry 'malpractice' if the $7,000 doesn't stick in an audit?

RobV (talk|edits) said:

12 December 2011
There again their comp number is up to you. You can make that decision on your own. I am just commenting on the only way to complete the return and still neet the requirements of comping out the owner. What if there is no income then they worked for the full year at less than min wage right?

Kevinh5 (talk|edits) said:

12 December 2011
Our point is whether it is our job to determine reasonable salary (as you do) or is it a question for the client to decide? And if the client chooses 'zero' as so many do? You seem to believe that zero is NOT OK, but some token amount (up to your discretion) IS OK. You change your client's books, never requiring them to comply with the spirit of the rules by filing 941s and W-2s. You are complicit in their deception. Maybe even more guilty than the client, as it was your decision/deception as to what number to use to throw the IRS off of the scent trail.

You risk losing your license as easily as the person who allows 'zero'. Maybe you deserve to lose your license even faster? Perpetrating a fraud is disreputable conduct, according to Circular 230. So is aiding and abetting a taxpayer in defeating a tax (or the proper tax).

RobV (talk|edits) said:

12 December 2011
Come on are you kidding me. 0.00 is not OK. We always meet with our clients and sit down and decide what the comp is through client discussons. If they come in late and it is way after year end, you have to pay comp on the tax return. I do think that is what this discussion is about correct?

You sure do read alot into a reply. I would never change a clients books without consulting with them. Did you just want to bait me into putting a number in a post so you could badger me? I gave an example for an S-corp that was not very profitable and the shareholder worked part-time.If you think 7K comp when they only made 20K and have 75K tied up in assets then that is your opinion, which over my time here you centanly do have a lot of. Who are you you tell me my license should be suspended.

Death&Taxes (talk|edits) said:

12 December 2011
If you think Shulman, Williams and company are not making an impact on the way people think, check out these discussions and others on No Salary S Corp (or reverse the wording) in the Search box. Very instructive.

Discussion: S- corp with no payroll, salary or distributions

Discussion: S Corp Owner Salary vs. Distributions

Captcook (talk|edits) said:

12 December 2011
Rob, with all due respect, these are the statements you made to which Kevin's comment "You change your client's books..." applies: "You decide on the comp just like you would for any other client. "; "There again their comp number is up to you. You can make that decision on your own."

What do you do with an S-corp showing a loss for the year? What is reasonable compensation in that instance? "0.00 is not OK."

Kevinh5 (talk|edits) said:

12 December 2011
Does anyone here believe that a tax preparer who pulls a number from the air in order to claim 'something' as officer's comp on a corporate return IS guilty of trying to cover the taxpayer's error? If the taxpayer never filed 941s and W-2s claiming this compensation, should that tax preparer be subject to sanctions for his/her actions?

I honestly think that the case is better made for the preparer reporting history correctly, rather than taking it upon himself to cover the taxpayer's wrongdoings by pulling numbers from his @$$.

BobTheMobCPA (talk|edits) said:

12 December 2011
I've got a lot of numbers up there, Kevin.

Kevinh5 (talk|edits) said:

12 December 2011
When you change history without the client's consent (or you provide the magic number which you think will fly), but the client doesn't issue the W-2 and 941 accordingly, it should be YOUR @$$ on the line, Bob.

RobV (talk|edits) said:

12 December 2011
Like I said in the prior posts, you and your client sit down and discuss proper decisions, and it all depends on the facts and circumstances of the situation. If you want to read into it that I was saying I make discussions and just do it, that was not the intent of the post. When I typed you, that is you as the trusted advison with your client.

You need to make your own judgment call on completing an S-corp return with no comp. I am pretty sure I have been educated in the fact that if an S-corp is showing income the owner needs to take some reasonable comp. Reasonable, what is that? Everyone has their own ideas on that and there are plenty of posts on this website describing reasonable comp. I would never comment that someone else’s judgement is wrong.

You can only try to get your client to do the correct thing, through educating them on the propery procedures. This is how we try to resolve the issue after the fact. If you do not agree that is OK. I was just giving an example of a way to try and resolve the clients neglect in paying payroll. If you want to amend payroll returns and have your client pay penalties and int feel free, I am not about to tell you that is wrong because it isn't, but the fact of the matter is if you pay the FICA tax on the 1040 it is paid, is there a timming diference? sure is. Has it been looked at? sure has. Has it ever been changed? nope.

Ckenefick (talk|edits) said:

12 December 2011
I honestly think that the case is better made for the preparer reporting history correctly, rather than taking it upon himself to cover the taxpayer's wrongdoings by pulling numbers from his @$$

I think most of us would agree with that...but the IRS' version of history is that the shareholder didn't take $0 compensation, but instead, all those Distributions he took were compensation and should have been reported accordingly. This puts us in a bind as return preparers. And I agree with RobV that putting some amount on a 1099 and reporting it on the guy's 1040 as fully subject to S/E tax is clear evidence of a good-faith effort to not evade his SS/Medicare obligation. It is the "next best thing" to actually filing the required payroll reports - not as good as filing 941's and 940's, but certainly better than letting things ride with $0 compensation being subject to SS/Medicare taxes. Maybe the 1099 route won't rise to the level of "substantial compliance," but it is nonetheless meaningful.

Will CPA (talk|edits) said:

12 December 2011
Here is a question what if you have an S-corp come in where nothings been filed for years, the owner paid themselves a small salary. Now filing the returns can you go with what they submitted for their payroll or would distributions have to be reclassified after the fact? Would the payroll have to be corrected 940's, 941's, and W-2's for those years after the fact?

IDrinkYour Milkshake (talk|edits) said:

12 December 2011
I have a client who is paid under a common payroll master. He gets a W2 from the one corp, but we allocate the correct percentage on his other, which is an S. He got audited because there officer comp reported, but no W2. We explained the common payroll master and provided documentation, all was taken care of through the mail.

Kevinh5 (talk|edits) said:

12 December 2011
There again their comp number is up to you. You can make that decision on your own.

Rob, you'll have to excuse me for interpreting your statement the way that I did.

Ckenefick (talk|edits) said:

12 December 2011
...and by the way, when I'm talking about putting something on the 1099 - this amount has to be the client's decision. If he says, "Put down $0 and don't file a 1099" we have a compliance issue if distributions have been taken during the year.

Kevinh5 (talk|edits) said:

12 December 2011
You don't think we have a compliance issue even if a 1099 WAS issued, Chris?

RobV (talk|edits) said:

12 December 2011
Ckenefick, I agree, If you meet with your client and advise them that they have to take some reasonable comp to be in compliance and they disagree, you have a decision to make. Do I disengage or do the return the way the client requested. Maybe the client thinks 0 comp is reasonable, that is there decision but I would document their thought process for the future.

Natalie (talk|edits) said:

December 12, 2011
Maybe the client thinks $0 comp is reasonable, that is there decision but I would document their thought process for the future. I'm curious how $0 would be reasonable, assuming there's a profit.

RoyDaleOne (talk|edits) said:

12 December 2011
I suggest the following:

JOSEPH M. GREY PUBLIC ACCOUNTANT, P.C., Petitioner v . COMMISSIONER OF INTERNAL REVENUE, Respondent UNITED STATES TAX COURT 119 T.C. No. 5

I would like some comments about the use of 1099-misc after reading the foregoing.

EatonCPA (talk|edits) said:

12 December 2011
Somewhat related situation that was just given to us today in CPE.

CPA in MO is in an audit representing a business client. Auditor says, "I see you indicated there were "Outside Services" paid - does that mean you issued 1099-MISC?" "Yes" answers the CPA. Auditor requests those 1099s. Auditor then proceeds to go 1099 by 1099 asking exactly what that person did for the firm, the nature of how the business was conducted, etc etc. Long story short - out of 10 1099s, the auditor decided 3 were actually employees. Taxpayer leaves, auditor then informs the CPA that it is the opinion of both the auditor and his supervisor that the CPA is subject to preparer penalties, $1,000 per return for improperly filing 1099s instead of W2s. Then auditor expands the scope back two years prior, sees the same three individuals provided with 1099s, and calls it a pattern and ups the penalties to $5,000 per - both for the preparer and the firm. $90k in penalties just that fast. So it doesn't matter if the client wants to hold these individuals out as independent contractors - now *we* have to make that determination??

The CPE instructor said that while that's the worst case he's heard, other preparers said they went through the same "1099" test in audits last year. Hopefully the guy in MO appeals and wins.

Death&Taxes (talk|edits) said:

12 December 2011
"I'm curious how $0 would be reasonable, assuming there's a profit."

A Husband-wife architecture/design firm I have made money for 3-4 years, took appropriate salaries and then when real estate went into the toilet, lost mucho money in 2009-10. The only way they have stayed afloat is a 100K loan, in the corporate name but guaranteed by the two. The losses are suspended for lack of basis. It appears they might make a small profit this year, but much of the money has gone to pay down the loan. (They live from the rental profits on another building from the wife's past, which nets 40-50K). There is no cash flow to take a reasonable salary. What would you do?


Discussion: S-Corp-Salary: file a (very) late 941 or issue a 1099? Might look at some of our heavyweighters circa 2008 weighing in here.

WEISSEA (talk|edits) said:

12 December 2011
I'm curious how $0 would be reasonable, assuming there's a profit.

Well try this real situation. Husband wife sole owners/shareholds of S corp. Wife runs S corp business on a daily basis with 15 employees. Wife takes salary and W-2. Husband has $200K fulltime job with large corporate employer. Well over FICA SS limit. Husband spends weekends working on the books, taxes, expansion of business etc, enough to be a material participant. Husband does not take W-2 under the logic he already has a fulltime job and is over SS limit. Is he required to take a W-2 for whatever time he spends on the business?

JR1 (talk|edits) said:

December 12, 2011
Eaton, my understanding is that there is no appeal! Amazing but true. You have to file legal action. Of course, for $45k it's worth it! But someone gave the auditors amazing ability to fine us when they're in the mood.

Death&Taxes (talk|edits) said:

12 December 2011
Roy: that case is a stacked deck.....personal services (tax prep at that). He wasted everyone's time.

Natalie (talk|edits) said:

December 12, 2011
D&T - agreed that the economic reality in that situation would seem to preclude taking a salary (and one of my clients may be in that situation for 2011). Does the IRS use common sense and accept that explanation?

Death&Taxes (talk|edits) said:

12 December 2011
As I said in the other thread, it is time to morph Bill Roth and crank up the Senate Committee again.

post removed - this person is not yet eligible to participate on the tax forum, let alone post offsite links

Ckenefick (talk|edits) said:

13 December 2011
I don't care for the argument that S-corp has loss so I decided not to pay myself.

Whether or not there's a loss is irrelevant. What's relevant is whether or not Shareholder Distributions are already on the books. If there are Distributions on the books, now the IRS has something they can reclass.

Roy: that case is a stacked deck.....

Roy's point is well taken, but the deck was more than stacked in Gray. The history is that Gray was a CPA and was advising numerous clients to take no W2 payroll. So, not only did they go after Gray, they went after five of his clients. Also, it is obvious from the record that Gray was uncooperative. And keep in mind that this wasn't about a preparer losing his license and wasn't about preparer penalties, which is what the OP is all about. So, Roy's point is well taken from the pure income/SE tax issue, but I'm not sure it's 100% relevant from the issued posed in the OP.

Death&Taxes (talk|edits) said:

13 December 2011
I agree with your conclusion, Chris, but that was the early 90's. Today the IRS' posture is different. I think the first thing they would do today is go after his ability to practice (though as a Public Accountant, he would have few rights).

Ckenefick (talk|edits) said:

13 December 2011
Again, I think it depends. Today, if a preparer acted like Gray, I do see the IRS throwing the book at him - filing a complaint with the state licensing board with the aim of revoking his license or with the aim of achieving some other sanction.

But let's say D&T has 100 S-corp clients and a few of them don't take W2 payroll in a given year (but maybe they do in future years). So, with an aim of substantially complying with the spirit of the law (i.e. paying FICA), you recommend that the shareholder put a "reasonable compensation" number on a 1099 and pay full S/E tax on it, I really can't see the IRS throwing the book at you, especially if you're cooperative and don't make any frivilous arguments. Sure, I can see the IRS not agreeing with your method, and asserting penalties and interest on the payroll reports, but I don't see the IRS throwing the book at you. These are two different things.

DaveFogel (talk|edits) said:

13 December 2011
Treating some portion of the S corp. distributions as wages is not "forcing" the client to take a salary. Rather, it's reclassifying the nature of the transaction so that it follows tax law, and we do this all the time with several types of transactions.

Nearly 35 years ago, the IRS ruled that where an officer or shareholder of an S corporation performs services for the S corporation and arranges to receive entirely dividends and/or flow-through income from the S corporation instead of being paid reasonable compensation, the portion of such distributions that is made in lieu of reasonable compensation for services is to be treated as wages. See Revenue Ruling 74-44, 1974-1 C.B. 287.

Several cases were decided during the past decade that held that if an S corporation has income that flows through to the officer-shareholder, or makes distributions of income to the officer-shareholder, and if the S corporation does not treat any portion of such income as wages, or treats only a small portion of such income as wages, then the entire amounts of the flow-through income will be treated as compensation for services subject to employment taxes. See Veterinary Surgical Consultants, P.C. v. Commissioner, 117 T.C. 141 (2001), affd. sub nom. Yeagle Drywall Co. v. Commissioner, 54 Fed. Appx. 100 (3rd Cir. 2002), cert. denied 123 S. Ct. 2623 (2003); Veterinary Surgical Consultants, P.C. v. Commissioner, T.C. Memo. 2003-48, affd. 90 Fed. Appx. 669 (3d Cir. 2004); Superior Proside, Inc. v. Commissioner, T.C. Memo. 2003-50, affd. 86 Fed. Appx. 510 (3d Cir. 2004); Specialty Transport & Delivery Services, Inc. v. Commissioner, T.C. Memo. 2003-51, affd. 91 Fed. Appx. 787 (3d Cir. 2004); Nu-Look Design, Inc. v. Commissioner, T.C. Memo. 2003-52, affd. 356 F. 3d 290 (3d Cir. 2004); Mike J. Graham Trucking, Inc. v. Commissioner, T.C. Memo. 2003-49, affd. No. 03-2757 (3d Cir. 2004); Water-Pure Systems, Inc. v. Commissioner, T.C. Memo. 2003-53, aff’d. No. 03-2756 (3d Cir. 2004); Joseph M. Grey Public Accountant, P.C. v. Commissioner, 119 T.C. 121 (2002), affd. No. 02-4417 (3d Cir. 2004).

Accordingly, at a minimum, the issue needs to be addressed in your file. If the facts support treating a portion or all of the S corp. distributions as wages for tax purposes, and if the client refuses to accept such a reclassification, then you should advise the client of the consequences of not following the law and of the penalties that may be imposed. Make sure that you’ve documented this. At this point, I think that you’ve done your job and have satisfied the requirements of section 10.21 of Circular 230 (knowledge of client’s omission). As to section 10.22 (diligence as to accuracy), if the facts support reclassifying the distributions as wages and the client says no, then I recommend withdrawing from the engagement because you could be violating this section.

But there are many factual situations where such distributions or flow-through income shouldn’t be reclassified as wages for tax purposes. One situation that comes to mind is where the client hasn’t taken any distributions and has made a business decision to leave the money in the corporation to cover future contingencies. Another situation is where the client didn’t perform any significant services, so no compensation needs to be paid.

RoyDaleOne (talk|edits) said:

13 December 2011
"Kevinh5 said:
12 December 2011

You don't think we have a compliance issue even if a 1099 WAS issued,"


Well the compensation issue goes away because the amount on the 1099 is compensation for services rendered, however, now there maybe an employee versus an independent contractor issue.

RoyDaleOne (talk|edits) said:

13 December 2011
Dave will you comment on Section 10.34 as to the part about disregard of rules or regulations? I am interested in your opinion on how that could be viewed by IRS.


Kevin ??? loss part of the post ???

The 1099 solves the compensation part of the question because the amount on the 1099 would be "compensation" for services, plus there is no longer a distribution to reclassify, however, now there is an issue of employee versus independent contractor.

Kevinh5 (talk|edits) said:

13 December 2011
Roy, that's exactly my point. Now the tax pro is helping the taxpayer file a false return (the 941s) as well as other documents (W-2/1099s). Plus I don't want to be the one suggesting/determining whether $7,000 was reasonable compensation when I know that the shareholder/officer worked full time for the corp and took $25K in distributions.

DaveFogel (talk|edits) said:

13 December 2011
"Dave will you comment on Section 10.34 as to the part about disregard of rules or regulations?"

Roy, after reading the current version of Circular 230 (Aug. 2011), I can't find the text that you quoted in your 12/11 post above that defines a disregard of rules or regulations. Perhaps it comes from another source, but you didn't cite it.

However, you asked me to comment on section 10.34. That section provides standards with respect to tax returns and other documents and in relevant part, it provides that a practitioner may not sign a tax return that the practitioner knows or reasonably should know that contains a position that either lacks a reasonable basis, is an unreasonable position, is a willful attempt to understate the client's tax liability, or is a reckless or intentional disregard of rules and regulations.

Willful in this context would probably mean that the practitioner knows about the law regarding the treatment of S corporation distributions as wages and prepares a return that doesn't treat them as wages. As a result, if the facts support treating a portion or all of the S corp. distributions as wages for tax purposes, and if the preparer signs a tax return that doesn't treat that portion of the distributions as wages, then in my opinion, the preparer has violated section 10.34.

RoyDaleOne (talk|edits) said:

13 December 2011
See Schneider & Company, Inc. v. United States, KTC 1999-376 (S.D.Ind. 1999)

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF INDIANA


SCHNEIDER & COMPANY, INC., dba JAMES J. SCHNEIDER, CPA, Plaintiff, v.

 UNITED STATES OF AMERICA, Defendant. 


Dave the citation is Regs. Sec. 1.6662-3. Negligence or disregard of rules or regulations, 1.6662-3(b)(2) hope that is correct.

Ckenefick (talk|edits) said:

14 December 2011
I'm glad Roy asked about 10.34 and I'm glad Dave answered it so well. Dave hit the nail on the head. And that's why those of you who think that all you have to do is advise the client to take W2 payroll, and your obligations end there, might need to rethink your position. Keep in mind we're talking Circ 230 here and there are preparer penalties to contend with as well. Did anyone notice that a few years ago the 941 began requiring a preparer signature?

Death&Taxes (talk|edits) said:

14 December 2011
"Roy, that's exactly my point. Now the tax pro is helping the taxpayer file a false return (the 941s) as well as other documents (W-2/1099s"

The problem many run into is that oft-times the client has done the 941s and the W-2s using Quickbooks and now, come March or later with extensions, the professional can only suggest these be amended. The professional can, of course, use the power of walking away from the client to coerce the client into amending, or go the 1099 route, or leave the money paid as distributions. If the client will not amend, the best case, if the moneies are labeled distributions, is leave them as such. If the pattern continues, he should walk away the next year. Naturally all is documented.

Death&Taxes (talk|edits) said:

14 December 2011
Is this it, Roy?

http://section6694penalty.blogspot.com/2008/06/schneider-company-inc.html

RoyDaleOne (talk|edits) said:

14 December 2011
Yes D&T.

MarkSC (talk|edits) said:

14 December 2011
Dave, I disagree with your interpretation of section 10.34 as it applies to S corp salaries. It is never an "unreasonable position" to report what actually occurred ($0 salary). "Position" in this context refers to a legal determination (as it affects tax return reporting), not a factual one. It is also certainly not a "willful attempt" to understate a client's tax liability if you are reporting what factually occurred.

RoyDaleOne (talk|edits) said:

14 December 2011
(2) DISREGARD OF RULES OR REGULATIONS. The term DISREGARD includes any careless, reckless or intentional disregard of rules or regulations. The term "rules or regulations" includes the provisions of the Internal Revenue Code, temporary or final Treasury regulations issued under the Code, and revenue rulings or notices (other than notices of proposed rulemaking) issued by the Internal Revenue Service and published in the Internal Revenue Bulletin. A disregard of rules or regulations is "careless" if the taxpayer does not exercise reasonable diligence to determine the correctness of a return position that is contrary to the rule or regulation. A disregard is "reckless" if the taxpayer makes little or no effort to determine whether a rule or regulation exists, under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable person would observe. A disregard is "intentional" if the taxpayer knows of the rule or regulation that is disregarded. Nevertheless, a taxpayer who takes a position (other than with respect to a reportable transaction, as defined in section 1.6011-4(b) or section 1.6011-4T(b), as applicable) contrary to a revenue ruling or notice has not disregarded the ruling or notice if the contrary position has a realistic possibility of being sustained on its merits.

The quote is from 1.6662-3(b)(2) and I ask MarkSC to "discuss" that regulation as it applies to S corp salaries.

Jossiecpa (talk|edits) said:

14 December 2011
I have a client that has a loss this year. Part of that loss is due to the fact that he's been paying himself a salary. He also has loaned the company money over the past few years, and has decided to stop paying himself a salary and consider all payments to himself as loan repayments, until the loan is paid off. How does the IRS handle a situation like this, when the shareholder is repaying his outstanding personal loans to the company, and not paying himself a salary?

Also, how do you handle a company that has $5,000 net income for the year, and the shareholder didn't pay himself a salary? What about $12,000 net income? At what point do you say to someone that they need to pay themselves? It just seems that those numbers are so small that they wouldn't warrant even being noticed by the IRS. Has anyone had an audit over an 1120S filed with no officer salary, but with net income in those low ranges?

I'm very concerned with the responsibilities that the IRS has been heaping onto us as tax preparers. We aren't policemen. I believe that we need to follow the law, and advise our clients accordingly. But I feel like we are being "used" by the IRS, with threats of penalties and sanctions, to do THEIR job, and to act as compliance offiers of the IRS. I just don't like where things are going. Maybe time to change jobs, except I have a son starting college next year. Not a good time to switch careers.

Jossiecpa (talk|edits) said:

14 December 2011
I have a client that has a loss this year. Part of that loss is due to the fact that he's been paying himself a salary. He also has loaned the company money over the past few years, and has decided to stop paying himself a salary and consider all payments to himself as loan repayments, until the loan is paid off. How does the IRS handle a situation like this, when the shareholder is repaying his outstanding personal loans to the company, and not paying himself a salary?

Also, how do you handle a company that has $5,000 net income for the year, and the shareholder didn't pay himself a salary? What about $12,000 net income? At what point do you say to someone that they need to pay themselves? It just seems that those numbers are so small that they wouldn't warrant even being noticed by the IRS. Has anyone had an audit over an 1120S filed with no officer salary, but with net income in those low ranges?

I'm very concerned with the responsibilities that the IRS has been heaping onto us as tax preparers. We aren't policemen. I believe that we need to follow the law, and advise our clients accordingly. But I feel like we are being "used" by the IRS, with threats of penalties and sanctions, to do THEIR job, and to act as compliance offiers of the IRS. I just don't like where things are going. Maybe time to change jobs, except I have a son starting college next year. Not a good time to switch careers.

MarkSC (talk|edits) said:

14 December 2011
"contrary to the rule or regulation." That is a legal position, not a factual one. It is never "contrary to a rule or regulation" to take a return position that is factually accurate. What rule or regulation is being violated by a taxpayer reporting $0 salary if that is what actually occurred? The legal fault was failing to pay the salary in the first place--not failing to report a non-existent salary on the tax return. Similarly, if a taxpayer is engaged in an illegal business (drug dealing), wouldn't you agree that he is obligated to report his illegal income on a tax return, notwithstanding that the activity itself might be contrary to law? Filing a factually inaccurate return can be a violation of Circular 230. Filing a factually accurate return can NEVER be a violation of Circular 230, even if the "fact" is something that may violate the law.

Ckenefick (talk|edits) said:

14 December 2011
Dave, I disagree with your interpretation of section 10.34 as it applies to S corp salaries. It is never an "unreasonable position" to report what actually occurred ($0 salary). "Position" in this context refers to a legal determination (as it affects tax return reporting), not a factual one. It is also certainly not a "willful attempt" to understate a client's tax liability if you are reporting what factually occurred.

This is your opinion and is a good one. The IRS' opinion is, as we would suspect, different. So, it's a matter of interpretation. The IRS would tell you that some or all of the Distributions were "factually" W2 pay all along. As to willfullness, I see your point, but I also see the IRS'. Hence my belief that filing a 1099 in this case, to comply with the spirit of the law, is better than doing nothing at all. I also think that the extent of non-compliance is relevant. That is, if you act like Gray, I can see the IRS going full throttle with a case against you as the preparer. But if the record shows that you advise clients to take W2 pay, and most clients do but a few of them do not, things weigh in your favor. There is also the issue of kicking the can down the road. If you fire the client, then another preparer will be presented with the exact same issues. Perhaps the IRS is trying to get ALL preparers to fix this problem with the filing of payroll reports, but I don't see that happening absent formal guidance. I think the 1099 route is somewhat of a happy medium. Of course, then we get into issues like: Can the shareholder make a personal SEP contribution based on the 1099 income?

Death&Taxes (talk|edits) said:

14 December 2011
This debate goes back to the concept of 'false return' the agent brought up in the OP's question.

"Provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all." That is the Mission of IRS.

DaveFogel (talk|edits) said:

14 December 2011
MarkSC, the S corp. salary issue IS a factual determination because the law is well settled.

For example, Jossiecpa gives the example where the S corporation has a small profit or a loss and asks the question of what is a reasonable salary under those circumstances. That's a factual determination. I can envision defending the position where the S corp. had a loss and didn't pay any wages to the corporate officer/shareholder because it didn't have any money to do so. I can also envision defending the position that the S corp. paid out to the officer/shareholder the small profit that the S corp. made during the year. These are factual determinations, not based on an interpretation of the law

MarkSC (talk|edits) said:

14 December 2011
What if a client reports a salary on the 1120S and files all of the payroll returns, but never actually issued a check for the salary or paid any distributions that could be recharacterized? Would IRS say that that is a "false return?"

MarkSC (talk|edits) said:

14 December 2011
MarkSC, the S corp. salary issue IS a factual determination because the law is well settled.

For example, Jossiecpa gives the example where the S corporation has a small profit or a loss and asks the question of what is a reasonable salary under those circumstances. That's a factual determination. I can envision defending the position where the S corp. had a loss and didn't pay any wages to the corporate officer/shareholder because it didn't have any money to do so. I can also envision defending the position that the S corp. paid out to the officer/shareholder the small profit that the S corp. made during the year. These are factual determinations, not based on an interpretation of the law

Sure, the question of whether a given salary is reasonable is a question of fact. My point is that, once the year is over and no salary has been paid, how is reporting a $0 salary on the 1120S a false return position or one that violates an IRS rule or regulation? The law says to file a return that accurately reflects the taxpayer's income, not to file a return that inaccurately reflects income because IRS wishes the taxpayer had done something during the year (pay a salary) that he didn't actually do. That's why I think my question about the falsely reported salary is interesting. A falsely high salary would be a distortion of income and violate the law. An accurately reported $0 salary that correctly reflects income does not.

DaveFogel (talk|edits) said:

14 December 2011
"My point is that, once the year is over and no salary has been paid, how is reporting a $0 salary on the 1120S a false return position or one that violates an IRS rule or regulation?"

As I stated in my Dec. 13th post above, "Treating some portion of the S corp. distributions as wages is not "forcing" the client to take a salary. Rather, it's reclassifying the nature of the transaction so that it follows tax law, and we do this all the time with several types of transactions."

For example, suppose that the client purchased an asset on 12/15 and treated this as an expense rather than a capital expenditure. After the end of the year, wouldn't you recharacterize the purchase as a capital expenditure, remove it from treatment as an expense and allow depreciation instead? Of course. Don't know why the issue of S corp. distributions should be treated any differently. It's not a false return position to reclassify the nature of the transaction so that it comports with the tax law.

Another example is a corporation that pays an officer/shareholder's personal expenses where there's a corporate resolution that says that such expenses are intended to represent additional compensation. Do you deduct the personal expenses on the return as business expenses (a false return position)? Or do you follow the corporate resolution and make an adjustment after the end of the year that reclassifies those personal expenses as compensation?

Jossiecpa (talk|edits) said:

14 December 2011
No one has addressed my question about the repayment of shareholder loans yet. If a client decides to have the corporation pay himself back during the year for $ he's loaned to the corporation, and not take a salary, would the IRS reclassify some of that $ as salary? It's not taken out as a distribution, but rather a loan repayment, as the client had to loan the $ to the corp in a prior year (in which he did take a salary) to keep it afloat.

RoyDaleOne (talk|edits) said:

14 December 2011
The shareholder loans repayment will work only if the debt is real debt with a note and interest etc.

Jossiecpa (talk|edits) said:

14 December 2011
Yes, the documentation exists and interest is being charged.

Jossiecpa (talk|edits) said:

14 December 2011
Actually, it was the sale of personal equipment to the corporation. The corporation now has a payable to the shareholder for the payment of this equipment. A receipt exists, and it was sold on the installment basis.

Death&Taxes (talk|edits) said:

14 December 2011
"Treating some portion of the S corp. distributions as wages is not "forcing" the client to take a salary. Rather, it's reclassifying the nature of the transaction so that it follows tax law, and we do this all the time with several types of transactions." (Dave Fogel)

"Does anyone here believe that a tax preparer who pulls a number from the air in order to claim 'something' as officer's comp on a corporate return IS guilty of trying to cover the taxpayer's error? If the taxpayer never filed 941s and W-2s claiming this compensation, should that tax preparer be subject to sanctions for his/her actions?

I honestly think that the case is better made for the preparer reporting history correctly, rather than taking it upon himself to cover the taxpayer's wrongdoings by pulling numbers from his @$$." (Kevin)

To me there is a chasm between those statements, and while Kevin was preaching to someone who seemed to imply he made the decision for the client, there seems to be an element of same with Dave F. In Dave's case, are 941's filed, though late, or amended in the case where there are other employees? Would you advocate having the client write up the decision to reclassify in the corporate minutes? I know some say minutes mean diddly, but I have seen on audit where RA's ask to see medical plans, note authorizations, and in the case of C Corps, salary authorizations.

I ask because Dave and Kevin are two of our most distinguished contributors.

DaveFogel (talk|edits) said:

14 December 2011
Just to be clear, I'm not preaching. What I'm saying is that if the facts support treating a portion or all of the S corp. distributions as wages for tax purposes, then they should be reclassified to reflect that treatment because that's what the law requires. In addition, I'm not recommending that the 941s should be filed late. You have until 1/31 to file the 4th quarter Form 941, which is 31 days after the end of the tax year. I'm also not saying that the decision to reclassify needs to be documented in the corporate minutes, although I don't see anything wrong with doing that.

Kevinh5 (talk|edits) said:

15 December 2011
My opinion is unchanged from the conclusions reached in some of those granddaddy of all S Corp Compensation discussions of yore (to which D&T has already linked):

It is the client's decision, ultimately.

e.g. If the S Corp had a significant (not token) profit, and the officer took no salary, but rather did take distributions/personal expenses, then I'd have the conversation with the client: "The IRS says you have to take a reasonable salary. Here are the options: A) Go back and amend your 941 and issue a W-2. B) Issue yourself a 1099 and pay the SE tax on your personal return. C) Leave it as is for the prior year (and let the chips fall where they may), but fix it going forward to take a reasonable salary. Here are some of the pros and cons I've identified for each choice......What do you want to do?"


I don't prefer option B, but concede that it's probably better than option C. I, like MarkSC, don't have a problem with filing a return showing zero officer's salary should the client choose option C.

Yes, I suppose this should be documented to the client's file. I honestly don't think that anyone would lose his license because he reported a client's tax return as actually happened. Yes, I do think a few practitioners should be scared into thinking that this topic matters enough that they should be concerned.

Yes, we should give advice, but I don't think that taking a position on the return that no salary was paid (when in fact none was) should result in a preparer penalty.


I understand and respect DaveFogel's opinion. A practitioner may, in good concience, object to a law when he feels that there is good reason for its' repeal or reversal. Remember, our history is full of miscegenation and prohibition type examples. Heck, even Bowers v. Hardwick was reversed in Lawrence v. Texas. Laws can be changed. Especially (but not limited to) when they are wrong. You will note that certain political parties keep bringing up the issue of abortion, long after Roe v. Wade. They obviously believe that the law of the land should be changed, in spite of what other equally intelligent people think. Don't Ask, Don't Tell may be a more recent cite of a law that has been changed because it is deemed to have been bad law, or at least it no longer is good law.

MarkSC's opinion that he should not be penalized for properly reporting history accurately is exactly the good-faith kind of belief that one must hold in order to take a position on a return contrary to the (case) law.

So now the question for Mark SC: Should you disclose this position on the 8275 just to be sure you don't get assessed a penalty? I'm thinking that one over myself, and might make it a requirement under Choice C above.

Death&Taxes (talk|edits) said:

15 December 2011
Dave does note the qualifier that 941s should not be filed late. As I noted above, the awkward point comes when the client walks in March 1st and the distributions have already happened. It is much easier to talk a client into doing something when it can be done timely, like 4th Quarter 941s. I think we all have to get used to using that saying "you're outta here" to serial offenders.

Kevinh5 (talk|edits) said:

15 December 2011
I'm beginning to think that the 8275 would work to CMA for those whom I normally would have said "you're outta here".

Ckenefick (talk|edits) said:

15 December 2011
I lean with Dave on this one. The courts and the RR make it pretty clear that if you worked for the busines during the year, withdrew money from the corp, yet didn't file payroll reports, what you withdrew is, either partially or totally, W2 salary. I would not want to put myself in a position wherein I have to defend myself by saying, "The guy took $0 formal salary, this is the history and I as the preparer can't change history." It seems to me the IRS will not buy this argument, and although I hate to admit it, the IRS has a point.

I lean with Dave, yet I do agree it is a matter of interpretation. If client gets audited and you cooperate with the IRS, tell the IRS the guy made a mistake or misunderstood your advice, yet client complied as best he could after the fact by issuing a 1099, the IRS will be sympathetic and may not even make any audit adjustments.

Your client would be a fool to allow an 8275 to be attached to his return for this issue. But then again, if client took no W2 payroll, he's already a fool.

Note that some taxpayers go the "no W2" route for one simple reason: They're fearful of a wage garnishment for one reason or another.

Kevinh5 (talk|edits) said:

16 December 2011
The 8275 protects the preparer against preparer penalties as much as it protects the taxpayer.

Ckenefick (talk|edits) said:

16 December 2011
I get that...but it is also a major red flag that could very well open up a huge can of worms.

Kevinh5 (talk|edits) said:

16 December 2011
I do the return without you taking a salary, an 8275 is required. You take the return to someone else? Their call.

Ckenefick (talk|edits) said:

16 December 2011
I do the return without you taking a salary, an 8275 is required.

Which return are we talking about - the 1120S? The 941's?

Michaelstar (talk|edits) said:

16 December 2011
Interesting Kevin. Not in disagreement or anything but interesting.....

So what kind of statement would you put in section III to comply with the intent of the form and hopefully at the same time, not trigger the darn thing as hinted by Chris?

edit - Chris - I was thinking Kevin is talking the 1120-S which is what my question pertains to

Ckenefick (talk|edits) said:

16 December 2011
I think Kevin's point is very well taken, as are all other points in this discussion.

JAD (talk|edits) said:

16 December 2011
How about generating a 1099-misc for a reasonable amount and obtaining the client's agreement to be on payroll going forward. Taxes are materially paid, and by the time the client is audited, he will have demonstrated an intention to comply since he will be able to show that he has been on payroll ever since the issue was discovered.

This worked for me in an audit of an S corp. The auditor acknowledged the issue, our attempt to correct, and moved on. It was a long time ago though, and the environment is much more tense now.

Ckenefick (talk|edits) said:

16 December 2011
I think that's a happy medium, as noted above. After all, what we're getting at here is the payment of FICA.

Kevinh5 (talk|edits) said:

16 December 2011
and FUTA, and if the state DOL steps in, SUTA. With unemployment at a recent high, and states unemployment funds running low, you can expect some effort on the part of the states to bolster revenues somehow. An IRS audit would be an easy thing to hitch your wagon to.

Captcook (talk|edits) said:

16 December 2011
I just heard seven states (including WA) will be receiving 1099 information from IRS and cross checking their records to ensure anyone receiving a 1099 is registered as a business in their state for payment of state business taxes/employment taxes. Seems the 1099 after the fact route may not be so safe after all.

Natalie (talk|edits) said:

December 16, 2011
That's really a good point, Captcook. In Hawaii, a 1099 would mean an additional 4 to 4.5% in general excise taxes.

Ckenefick (talk|edits) said:

16 December 2011
It's not a great point. What it may cost you at the state level is not outweighed by taking a good-faith, substantial compliance position at the federal level.

If you're telling me you don't want to issue a 1099, then your options are (1) file/re-file all of the federal and state payroll reports (2) do nothing. And with #1, you would logically have to ascertain which Distributions you wish to reclass to salary, which may span over the entire 4 quarters. Then, of course, you'll have to compute all the penalties and interest for each quarter or deal with the slew of tax notices that comes your client's way.

Captcook (talk|edits) said:

16 December 2011
I looked back at the presentation we had. The other six states are: Connecticut, Maryland, Utah, Massachusetts, Minnesota and Missouri. I'm betting this program will be expanded very soon.

Natalie (talk|edits) said:

December 16, 2011
What is your problem, Chris? I didn't say "great," I said "good." And I also didn't say I wasn't going to issue a 1099 -- I was merely pointing out another consideration.

Captcook (talk|edits) said:

16 December 2011
I don't know about you, Chris, but my experience with state agencies basically would tell me I have a 90% chance of the state reclassifying the amounts as wages and requiring all related employment reports. If the state does that, you can bet the IRS will be next in line. With this in mind, I'm more inclined to follow Kevin's approach with an 8275 than to issue a 1099 for "reasonable compensation" and wait for the state agencies to nail my client to the wall.

Kevinh5 (talk|edits) said:

17 December 2011
This accountant tried a different approach to avoid FICA/SE tax. http://www.ustaxcourt.gov/InOpHistoric/arno5ld.TCM.WPD.pdf

Ckenefick (talk|edits) said:

17 December 2011
With this in mind, I'm more inclined to follow Kevin's approach with an 8275...

Yikes. You may as well send a letter to the IRS inviting the audit. Then once this happens, your client might sue you for a breach of ethics, seeing that you attached the 8275 primarily to cover your own ass.

MWPXYZ (talk|edits) said:

17 December 2011
Do any/many/all states workers compensation laws and unemployment tax laws recognize reasonable compensation as compensation. In NH a corporation need not cover its officers (up to 4 in number). Moreover, don't most states assess an unemployment tax on a minimal amount of compensation?

Death&Taxes (talk|edits) said:

17 December 2011
There is a difference between WC insurance and unemployment tax in most states. PA and NY (last time I looked) do not require coverage of officers for workers comp, but require payment for unemployment. New Jersey covers officers for both.

Captcook (talk|edits) said:

18 December 2011
"[B]reach of ethics"? Let's get real. Do you think I wouldn't have discussed the ramifications with the client beforehand? It is their return. They have to understand what it contains. Furthermore, I (and you, I'm sure) do a lot of things primarily to cover ourselves and not necessarily the client. If the client was on the straight and narrow, the discussion would never exist. Anything other than going back and filing 941s, et al. is questionable treatment as it relates to reporting reasonable compensation.

Ckenefick (talk|edits) said:

18 December 2011
Do you think I wouldn't have discussed the ramifications with the client beforehand?

I hope so, including these points:

1. Client will most likely end up being audited, perhaps for multiple years. 2. The 8275 filing covers my ass as the preparer. (And of course, client will wonder if this is the "real" reason its being filed).

Then you must also think about those similarly situated clients for which you've prepared returns in the past and have "done nothing" to fix the W2 issue, and have not attached an 8275. You must think about this because if the IRS locates these clients, with you signing as preparer, you might have a bigger issue on your hands.

So, if client says "No way I'm filing that 8275 form," then you won't be able to sign the return. After all, you've admitted that the 8275 is required.

And if client says, "Ok, let's attach the 8275." Then guess what, client gets audited and sues you, whether frivilously or not. Client asserts that an 8275 should not have been filed and he was given bad options and faulty advice and the only reason the 8275 was attached was to protect the preparer. Client asserts that the 8275, if it should have been attached to anything, should have been attached to the 941's.

Wouldn't it just be easiest to issue the guy a 1099..and fix things prospectively?

Wouldn't these acts of compliance weigh heavily in the client's favor?

And wouldn't these acts also protect you, as the preparer, because you saw to it that FICA was paid, even if it was technically paid in the wrong way?

The 8275 route is not a good alternative, in my opinion.

Kevinh5 (talk|edits) said:

20 December 2011
You merely explain the client's choices, and point out that the 8275 does protect both the preparer and the taxpayer from penalties if the issue is adequately disclosed.

For the last 5 years, I have been asking most of my ethics classes around the country whether anyone has ever used a Form 8275. Of those responding affirmatively, I then inquire whether the 8275 resulted in an audit.

Tabulated results: Over a hundred people have attached 8275s, only 1 audit resulted.


Chris, your concerns of audit are unwarranted.

Pink Pearl (talk|edits) said:

20 December 2011
for what it's worth...[1]... sounds like the form might ward off an audit.

Illini (talk|edits) said:

20 December 2011
Isn't the use of Form 8275 a "catch 22"? Because you have to have a valid reason for taking the position you are on the Form 8275? Client refused to take my advice to prepare W-2s is not a valid position is it?

Ckenefick (talk|edits) said:

20 December 2011
Chris, your concerns of audit are unwarranted.

First off, that was then, this is now. And I wonder how many of these 8275's actually involved the issue at hand - an S-corp shareholder that took $0 salary.

All it takes is 1 client to sue you. But be that as it may, you can choose whatever method you and client agree upon. If an 8275 is filed, and client gets audited, you will assuredly lose. Not only have you taken a position that is contrary to existing authority, you have red flagged your position to the IRS. The only person that stands to gain from this act is the preparer. Yet if you file a 1099, you have a much greater chance of success - and so does the client.

MarkSC (talk|edits) said:

20 December 2011
I would not file an 8275 for this issue. How would that solve anything? Either you believe that reporting $0 wages on the 1120S is contrary to the law, or you agree with me that it is not. If you fall into the first camp, what is the reasonable basis for taking a return position that is contrary to the law? Form 8275 only works if the return position has a reasonable basis. For that matter, why is reporting $0 on the officer salary line not adequate disclosure of the return position?

I would love to see IRS arguing that an 1120S return reporting $0 wages is contrary to the law and requires preparer penalties. That is such a laughable argument. That would mean that a return that simply makes up, say, $50k of wages (why stop there?) in order to report the wage "correctly" is somehow consistent with the law even though it results in an excess deduction and thus an understatement of tax liability for any other shareholders. Which return position do you think opens you up to penalties? Can a client similarly make up a wage number on an 1120 return if $0 wages were actually paid?

Coddington (talk|edits) said:

21 December 2011
I don't practice in this area, so my interest is mainly academic, but my understanding of the issue was that only the Service has the authority to recharacterize distributions or loans as salary. If so and given an appropriately unreasonable factual situation, a Form 8275 would be in order only if there was some way to apply to the Service for them to determine the reasonable comp issue and the return needed to be filed while the issue is pending. Since PLRs and determination letters are not supposed to be used for inherently factual issues, I don't see how an 8275 would be useful. In other words, our only option would be to withdraw and let the taxpayer take his or her chances with the guy down the street or self-preparing.

I think the solution to this problem is to bug our respective professional associations, state boards and bars, and the IRS to accept this issue into the Industry Issue Resolution program to issue guidance that provides a method for preparers to resolve this issue.

Podolin (talk|edits) said:

3 January 2012
This WSJ article involves a CPA. He lost and says he may appeal. There were penalties. [[2]]. Interestingly, the article (I have not read the case yet) says the IRS-determined salary was about 70% of his actual earnings as a CPA. Not clear how they got there.

Ckenefick (talk|edits) said:

3 January 2012
This was a great case - Iowa District Court - And the court's approach was very interesting in how they arrived at the shareholder's salary. Basically, the court looked around the area to see how much other CPA's made...and that's it. Pretty reasonable if you ask me.

Ckenefick (talk|edits) said:

3 January 2012
...and I'm not sure what you mean by the 70% number.

DaveFogel (talk|edits) said:

3 January 2012
Podolin, the WSJ article is almost a year old. Mr. Watson did, in fact, appeal to the 8th Circuit, and the case was argued and submitted on 11/15/2011. The 8th Circuit should be issuing its ruling sometime within the next several months.

Podolin (talk|edits) said:

3 January 2012
DaveFogel - I read the article too quickly. It was in Accountants World Daily news and described as the top read news story of 2011. Sorry.

As to the 70%, I jumped the gun there too. Following is from the article.

"What is a fair ratio of profits to pay? There isn't one answer, experts say. A company with substantial capital or assets, such as a manufacturer, often is able to justify lower pay than one selling personal services like a law or accounting firm. Says Mr. Willens: "I would tell a client that for personal services, 70% would be the absolute floor and might not get the job done," he says.

In Mr. Watson's case, his revised compensation came to only about 40% of his total return from the company. The upshot: Pay can vary—but it can't be too low."

Szptax (talk|edits) said:

4 January 2012
I had the a, b or c option discussion with a client as described by Kevin 5 above. He went elsewhere - to a local CPA/attorney who didn't have a problem with the no salary issue. The distributions were low, but they were the entire net profit of the S corp and he was the only worker. He shouldn't have been an S corp and was unwilling to dissolve the corp and form an LLC.

I think the problem with the small S corps is that they shouldn't be S corps. People form them with grand plans for success that doesn't materialize. And in most of these cases, the owner claims that they didn't know of the salary requirement. They claim the attorney never told them. I only buy that argument for a year or so. 1 year for not knowing (though they should have) and another for trying to fix it. After that, no excuses. Terminate the S corp & get a do-over.

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