Discussion:Reasonable compensation audit

The auditor states "corrected wages will be $45,000 in 2006, $60,000 in 2007 and 2008" for the manager shareholder. Of course we will be disagreeing. Restaurant managers in our city make around $44,000 according to salary.com and payscale.com. We will even go to each restaurant manager in the city to find out what they make to support our case.

The funny thing is that she wants to move the shareholder's distributions to wages. When I commented that this will make them have uneven distributions (since one shareholder doesn't work in the company) and cause problems for the S-corporation, she said that is up to me to fix.

I got the tip from a friend who does immigration - I think she uses it to justify H1-B compensation.

http://www.businessweek.com/bwdaily/dnflash/content/oct2008/db2008108_844949.htm?campaign_id=rss_daily

Sorry for the diversion.

Had the Wage base been say 36K, this most likely would not have occured. I went through this last year, and the auditor produced comp wages suing SIC codes and the like and bumped us from 30K to 60K which I negotiated down to 45K or so.

My personal view, for spirit of the law and safety, is that distributions should never exceed W2 income until W2 income nears 6 figures.

I am not saying there's nothing else on the table except the manager's services, and his compensation, but that those two items are subject to negotiation between the two shareholders.

I don't know how to bring this to bear on the question of reasonableness, however. A clever/experienced/gifted debater should be able to make something of it. Show the IRS agent that every dollar that the worker gets is 50 cents that the non-worker doesn't get. That's arm's length. And she's got less leverage to mess with something that's at arm's length.

And I think the issue of the payments toward the new store will be a big issue, too. Were they deducted when paid? Is the new store already in a separate S corp?

Not to mention the threat to the corporation's S election...

Please spell Mr. Buffett's name correctly, Roy. Thank you.

The significant difference is that Jobs and Buffet do NOT tax distributions so there is NOTHING to reclass. They take dividends from a C corp in PROPER proportion to their ownership.

if you take NO distributions in an S Corp they CAN'T make you declare salary.

This is a dist vs salary debate not a reasonable comp debate alone.

And please spell Mr. Buffett's name correctly, Southparkcpa. Thank you.

Apology to all...............

Sometimes the auditor says "Jump" and all you can do is reply, "How high?"

1. S corp taxable income is taxable to shareholders regardless of whether or not there are distributions.
2. Unreasonably low compensation of S corp. shareholder/employees is an issue whether or not there are distributions.
3. Unreasonably high compensation of shareholder/employees is the issue with C corps, although not so much since the advent of preferential taxation of qualified dividends. -- Larry Hess, CPA | Albuquerque, NM

What cite are you relying on for the thought that NO ditributions in an S can still be subject to salary.

I represented a company many years ago that had in excess of 100K of flow through income , paid NO wages to the shareholder for several reasons and the auditor made mention of low comp but chose to ignore it because he could not cite anything.

I see your point but just curious.

The Internal Revenue Service Does Not Always Address Subchapter S Corporation Officer Compensation During Examinations

Agree that compensation should be in the minutes, but it seems this is a case by case matter,

TexCPA 23:37, 10 May 2009 (CDT)

I have read elsewhere that the IRS may state they are looking at one issue, but the issues are found by expanding to other years and returns. At least I got it away from being a tip audit.

Of course, you cannot "doctor" the minutes to suit your present purposes. However, the lawyer can put together the last few years based upon the honest memory of the two compadres, and get them on the right track for the future.

1. qualification, duties and time spent
2. ability of company to pay salary
3. comparison of salaries in similar (salary.com)
4. frequency of pro-rata 'distributions' vs. salary
5. salary policy in corp minutes
6. comparison of salary and distributions

anyone want to add or delete?

TexCPA 20:47, 11 May 2009 (CDT)

Using common law would be the strongest argument for you to make against the IRS's position.

T.C. Memo. 2006-36

See Issue #8 (page 138)

TexCPA 23:42, 11 May 2009 (CDT)

I have some other deductions (that were actually coded to distributions!) to include in the 2006 & 2007 returns which I need to work through to see what the net cash affect will be before I argue with her.

The problem this would then raise is that the corporation would now owe the working shareholder his $25K distribution (or the other shareholder would owe him $12,500!

Questions - 1. Since other years are closed, can they really look back at historical wages to justify the wage increase? 2. The adjustment is $3,251 for FICA/Medicare and $1,980 increase in tax on the shareholders personal return (other shareholder will receive a $2,860 refund if he is at the 25% rate - I haven't seen his personal return). In your opinion, is this worth arguing over? 3. With a range of $40,000, it seems we could negotiate the increase. For example, we could do a survey of other restaurants in town to come up with a better number. However, since the officer is claiming tips to get to his $21,714 in income, the officer compensation expense to the corporation was actually $14,514. I don't really want her to think about this further.