John Bullis: IRS often reviews S corporation income tax returns
The income tax return for a corporation that has elected to be taxed as an S corporation lists the owner’s wages and the remaining profit (which is taxed on the owner’s income tax return). The S corporation does not usually pay an income tax.
The wages are subject to payroll taxes (Social Security and Medicare) just like any other employee. But the net profits (hope there are some) are subject only to income tax. The net profits are not subject to the payroll taxes.
You can guess why the IRS has targeted S corporation income tax returns for special review. The lower the wages are and the more the profits are, the less payroll tax paid by the owners. The IRS is checking those returns to see if the wages paid to the owners are “reasonable.”
There are many factors in determining whether the owner wages are reasonable. It is usually what would be paid to someone else for the same services the owner provides.
Other factors in determining the reasonableness include the duties performed; the character and amount of responsibility; the time required; the ability and achievements; the volume of business handled; the complexities of the business; the relationship of the wages to the gross income and the net income of the business; the cost of living in that area; the history of compensation; and the salaries paid to non-owner employees.
It is good to document what is done by the owner and try to pay reasonable wages. That will avoid problems with the IRS in the future.
Some folks have asked if Social Security will still be around when they retire. I think all members of Congress want mainly to be re-elected. If they cancel or change Social Security in a big way, that might not happen.
Having enough wages to qualify for Social Security benefits in the future is probably a good idea. Some folks don’t realize a lot of Social Security benefits are paid to young people who qualify as “disabled.”
Some corporations are not able to pay reasonable wages in certain years (cash flow is too low, economy-reduced sales and profits, etc). If that happens, it is good to note in the minutes (and otherwise) that more wages were earned than were paid. Then, when the corporation can pay more wages, some of those wages are “earned in prior years but only paid now.” That will help explain why reasonable wages in one year are significantly more than in prior years (especially if the return is done on a “cash basis” method of accounting.
Did you hear? “When you are dissatisfied and would like to go back to youth, think of algebra.” — Will Rogers
John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.