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In this section we present you with short newsletters containing
timely and useful information. |
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What's the "right amount" of compensation for an S Corporation
Shareholder/Employee? |
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The S corporation has been used by small business owners to avoid
payroll taxes, and the IRS knows it. Here is a case that describes
how a CPA got into trouble with his own S corporation--and how you
can avoid the mistakes that were made. |
A recent unpublished opinion of the U.S. Tax Court provides an
important insight into the issue of "reasonable compensation" when
considering a defensible minimum amount for an S corporation
shareholder/employee. Many tax advisors agree that you can use this
opinion as reliable guidance (even though it is not binding
precedent) when planning such compensation. Here's a brief summary
of the relevant facts and the Court's decision.
Wiley Barron, a CPA, formed an S corporation to practice public
accounting in Arkansas. The S corporation made substantial
distributions of profits to him, but treated only $2,000 - - in one
quarter during a three-year period - - as compensation subject to
employment taxes. The S corporation was examined for payroll tax
compliance by an IRS "officer/examiner" specially trained to deal
with worker classification and payroll tax issues. She assessed
payroll tax deficiencies to account for reasonable compensation and
Wiley appealed to the U.S. Tax Court, where he represented himself
under the Court's small case procedures.
In its Summary Opinion, the Tax Court said that Wiley "was the
individual who was solely responsible for making management
decisions and for controlling every facet of (his) business." He was
the only CPA employed by the corporation, he worked at it pretty
much full time, but he didn't pay himself a salary. Since the
general rule is that a corporate officer is an employee [See
Internal Revenue Code Section 3121(d)], it's fairly obvious that Mr.
Barron was using his S corporation to avoid employment tax on his
compensation: in this case, all or part of the S corporation's
earnings which were distributed to him.
Mr. Barron is certainly not the first small business owner to use an
S corporation to avoid payroll taxes on his income, and the IRS has
aggressively pursued many of them. Until now, the position of the
IRS had been - - and the Courts had generally agreed - - that the
entire amount of S corporation distributions should be reclassified
as compensation.
But the outcome of this particular case is unique and offers
guidance for establishing reasonable compensation at less than total
distributions from the S corporation. The Tax Court agreed with the
revenue officer/examiner's proposed adjustments, which were based on
information from Robert Half Associates regarding what "reasonable
compensation" for a CPA of Mr. Barron's training and experience
would be - - in the area of Arkansas where he practiced. That
"reasonable compensation" was in the range of $45,000 to $49,000 for
the years in dispute. Even though the S corporation had distributed
from $56,000 to $83,000 in those years, only the amount of
"reasonable compensation" based on the reliable comparable data was
recharacterized as compensation and subjected to Social Security and
Medicare taxes.
You do not have to live with uncertainty on this issue. We can
assist you in determining reasonable compensation levels for S
corporation shareholder/employees and have full access to reliable
comparable data and a complete library of federal tax reference
material. Please Contact Us to
schedule an appointment.
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