FOR LIVE PROGRAM ONLY Mastering the Rules of S Corporation Shareholder-Employee Compensation WEDNESDAY , FEBRUARY 1, 2017, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours . To earn credit you must: • Participate in the program on your own computer connection (no sharing) – if you need to register additional people, please call customer service at 1-800-926-7926 x10 (or 404-881-1141 x10). Strafford accepts American Express, Visa, MasterCard, Discover . • Listen on-line via your computer speakers. • Respond to five prompts during the program plus a single verification code . You will have to write down only the final verification code on the attestation form, which will be emailed to registered attendees. • To earn full credit, you must remain connected for the entire program. WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations : -Call Strafford Customer Service 1-800-926-7926 x10 (or 404-881-1141 x10) For Assistance During the Live Program : -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.
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Mastering the Rules of S Corporation Shareholder-Employee Compensation Feb. 1, 2017 Samuel D. Brotman, Attorney Jason Watson, EA, MBA, Managing Partner Brotman Law, San Diego Watson CPA Group, Colorado Springs, Colo. sbrotman@sambrotman.com jason@watsoncpagroup.com 619-378-3138 719-387-9800
Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
S Corp Reasonable Compensation Agenda • Origins, IRS Definition – Jason Watson • Audit Risk – Jason Watson • Tax Court Points – Jason Watson • Tax Court Cases, Facts and Results – Samuel Brotman • Keys to Reasonable Salary – Samuel Brotman • Health Insurance, Competing Interests – Jason Watson • Questions and Answers 5
Origin of Reasonable Compensation • IRS Revenue Ruling 74-44. • 1974 ruling states that dividends paid to employees who drew no salary were “wages” subject to withholding and employment taxes. • Holding: “The ‘dividends’ paid to shareholders…were in lieu of reasonable compensation for their services.” • Revenue ruling draws the distinction between compensation and distributions out of the corporation’s earnings and profits. 6
IRS Definition – Fact Sheet 2008-25 • August 2008, not updated since. • “ S corporations should not attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages .” • “ However, if cash or property or the right to receive cash and property did go to the shareholder, a salary amount must be determined and the level of salary must be reasonable and appropriate .” • Minor services, investor only. 7
IRS Definition – Fact Sheet 2008-25 (cont.) • Training and experience • Duties and responsibilities • Time and effort devoted to the business • Another source of income? Another W-2 job? • Dividend history (old school from C Corp days, really distributions) • Payments to non-shareholder employees • Clerical versus sales versus managers • Timing and manner of paying bonuses to key people • What comparable businesses pay for similar services • Compensation agreements • The use of a formula to determine compensation 8
IRS Definition – Fact Sheet 2008-25 (cont.) • Website www.irs.gov/uac/Wage-Compensation-for-S- Corporation-Officers or using our simple re-direct www.wcgurl.com/8247 9
S Corp Audit Risk • Generally, only 0.4% of S Corps are audited for income tax. • However, according to the Government Accountability Office (GAO) S corporations that pay little to no wages and have large shareholder distributions account for most IRS examinations in this area. The Treasury Inspector General has given marching orders to the IRS. • The 1120S line 7 (compensation of officers) can be compared to line 21 (ordinary business income) • Also…1040 lists W -2 and K-1 both with EIN and SSNs, and it easy for the IRS to design a trigger for examination. • Further, S corporations with one to three shareholders made up almost all of the compensation underpayments reviewed by the IRS. 10
Tax Court Points • There are two tests that tax courts have used in the past. In Label Graphics, Inc. v. Commissioner, Tax Court Memo 1998-343 which was later affirmed by the 9 th Circuit Court in 2000, the court came up with- • The employee’s role in the company . • A comparison of the compensation paid to similarly situated employees in similar companies. • The character and condition of the company. • Whether a relationship existed between the company and employee that may permit the company to disguise nondeductible corporate distributions as deductible compensation. • Whether the compensation was paid pursuant to a (1) structured, (2) formal, and (3) consistently applied program. 11
Tax Court Points (cont.) • In Brewer Quality Homes, Inc. v. Commissioner, Tax Court Memo 2003-200 , the court re-iterated several points from another federal court case ( Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d 1315 (5th Cir. 1987) )- • The employee’s qualifications . • The nature, extent, and scope of the employee’s work . • Size and complexity of the company. • Comparison of the employee’s salary with the company’s gross and net income . Prevailing general economic conditions. • Comparison of salaries with distributions to stockholders. 12
Tax Court Points (cont.) • Brewer Quality Homes, Inc. v. Commissioner, Tax Court Memo 2003- 200 continued… • Compensation for comparable positions in comparable concern. • Salary policy of the company as to all employees. • Amount of compensation paid to the employee in previous years. • Tax court in K & K Veterinary Supply, Inc. v. Commissioner (Tax Court Memo 2013-84) used the Brewer decision and subsequent criteria to generate “plusses and minuses” for the taxpayer to determine if the salary was reasonable. 13
Reasonable Compensation Cases – Radtke v. U.S., 895 F.2d 1196 (7th Cir. 1990) • Dividends paid to sole shareholder who was also sole employee of his professional corporation were really wages. • Facts: Lawyer was sole shareholder and sole full time employee of his professional corp. Took no compensation, only dividends. IRS assessed deficiencies for failing to pay FICA and FUTA. • Holding: “We agree with the district court that the payment to this employee…constituted wages subject to FICA and FUTA contributions. FICA and FUTA broadly define ‘wages’ as ‘all remuneration for employment’ and the Treasury regulations are similarly bound. 15
Reasonable Compensation Cases – Ulrich v. U.S., 692 F. Supp. 1053 (D. Minn. 1988) • An offers who renders substantial services is an employee. • Facts: Sole shareholder of an accounting corporation was also the sole director and officer of the corporation. All shareholder’s income was dividends from the corporation. • Holding: “Under both the weight of the case law and under the treasury regulations, a corporate officer is to be treated an employee if he renders more than minor services.” 16
Reasonable Compensation Cases – Spicer Accounting v. U.S., 918 F.2d 90 (1990) • Facts: Accountant was the only accountant working at his firm, working an average of 36 hours per week. Accountant and wife each owned 50% of the stock. Accountant was president, treasurer and a director of the corporation. Accountant never took any salary, only dividends. Said he “donated” services to the corporation. • Law: “The Federal Insurance Contributions Act and Federal Unemployment Tax Act both define ‘wages’ as ‘all remuneration for employment.’ Treasury Regulations on Employment Taxes and Collection of Income at Tax Source….provide that the form of payment is immaterial, the only relevant factor being whether payments were actually received as compensation for employment.” 17
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