HOT IRS Audit Issue - Guidelines for S-Corporations
Officer compensation for shareholders of subchapter S corporations is on the IRS hot list. S-Corporation officers notoriously take low salaries so they can receive the bulk of their corporation's profits as dividends, which are not subject to payroll taxes. The IRS is now taking a closer look at the practice, and the agency continually wins most of the cases it prosecutes.
In a recent case, an owner took a $24,000 salary in a year when his share of the firm's profits was approximately $200,000. The IRS challenged, and a district court agreed that his pay was unreasonably low and ruled that the dividends needed to be re-characterized as salary.
The consequences of misinterpretation or abuse of the law can be quite costly. The liability can add up to as much as two to three times what would have been due originally had reasonable compensation been paid in the first place. No two cases are the same, but the courts consider the following 10 factors:
It is important to review your policies, procedures and record-keeping. What was reasonable several years ago may not be considered reasonable today. Then you will be able to identify what is reasonable in your industry based on the services that you provide.
Officer compensation for shareholders of subchapter S corporations is on the IRS hot list. S-Corporation officers notoriously take low salaries so they can receive the bulk of their corporation's profits as dividends, which are not subject to payroll taxes. The IRS is now taking a closer look at the practice, and the agency continually wins most of the cases it prosecutes.
In a recent case, an owner took a $24,000 salary in a year when his share of the firm's profits was approximately $200,000. The IRS challenged, and a district court agreed that his pay was unreasonably low and ruled that the dividends needed to be re-characterized as salary.
The consequences of misinterpretation or abuse of the law can be quite costly. The liability can add up to as much as two to three times what would have been due originally had reasonable compensation been paid in the first place. No two cases are the same, but the courts consider the following 10 factors:
- Duties and Responsibilities
- Time and effort devoted to the business
- Training and experience
- Dividend history
- Payments provided to non-shareholder employees
- Compensation agreements
- What comparable businesses pay for similar services
- Compensation agreements
- Timing and manner of paying bonuses to key people
- Any formula used to determine compensation
It is important to review your policies, procedures and record-keeping. What was reasonable several years ago may not be considered reasonable today. Then you will be able to identify what is reasonable in your industry based on the services that you provide.
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