Good Morning Gentle Readers,
Although this was written seven months ago, it languished in the draft box until I realized this morning that this was supposed to be up back in July. Hmmm. Our policy is to always blame the computer, so there ya have it. Old news is better than no news I suppose.
Traditionally small 'C' and 'S' corporations have, for the most part, escaped close scrutiny by IRS because it has been far more cost effective for the IRS to focus on higher income Schedule C filers.
Today, about 60% of all corporations in America are 'S' Corporations and the IRS has decided to take a harder look at a few of them. Five thousand of them to be precise. In the overall scheme of sheer numbers, that isn't a huge uptick in the risk of audt to the average 'S' corporation, but those who get the nod will find themselves in for a treat as this is a research project.
"The use of S-corporations has exploded," said IRS Commissioner Mark Everson. "The IRS needs a better understanding of what this means for tax compliance."
A similar study of individual tax returns determined that taxpayer chicanery in 2001 ensured that an estimated 350 billion dollars stayed in the hands of those who earned it instead of being shoveled into government furnaces in DC.
It is pretty much a given that one signficant focus of these random audits will be owner/stockholder compensation. If the owner/stockholder works for the 'S' corporation he or she must receive a salary. That sounds like a given but because of the quirky nature of S corporations, (dividend) distributions are not subject to social security (self-employment) taxes. I was trying to get that last sentence into English and what it boils down to is that when you take money out of the S corporation it is treated like a draw from a partnership or a sole-proprietorship, but in reality the profits are what is distributed and those are taxable but unlike a partnership the profits are technically dividend distributions and therefore are not subject to self-employment (social security tax). Not surprisingly, there is an exploitable incentive there and owner/stockholders have used that to their advantage over the years often saving as much as ten thousand dollars a year per owner in self-employment tax. IRS doesn't like that and insists that there has to be reasonable salaries paid to owner/stockholders.
Our compromise is to peg the salary at say $40,000.00-$50,000.00 per year, which still saves thousands in self-employment tax. Disclaimer: no guarantees that this strategy will work every time and the specifics are beyond the scope of this discussion.