I noticed a headline in today’s Orange County Register that grabbed my attention: “IRS Will Audit 5,000 Firms to Gauge Unpaid Taxes Nationwide” (one-time registration required). Then I read the article. If I hadn’t had heartburn before, now I did. After talking for several years about looking at S Corporations, the IRS has finally decided to see how bad the salary problem is. (You can find the IRS’ news release here.)
S Corporations are the most popular form of corporate ownership in the US because of their pass-through nature combined with liability protection. While S Corporations do not (generally) pay taxes, they must file returns; the owners of the S Corporations include their shares of the income on their individual (1040) returns.
Over the past few years, whenever I attended meetings with enforcement personnel from the IRS, they mentioned that (they believe) that many owners are not taking required salaries from their S Corporations and instead are taking all distributions as dividends (which allows them to avoid payroll taxes). Owners do need to take “reasonable” salaries. Of course, there is plenty of room for debate on what is reasonable. However, it’s unlikely that the Tax Court would find $0 reasonable.
In any case, the IRS now wants to quantify this problem (and any others they may find) by returning to…the audits from hell.
I’ve missed out on these (thankfully), but these audits were of people unlucky enough to be randomly selected and had to justify every line of their individual return, and usually had to state what every deposit in their bank accounts represented. Ugh.
Now, under the guise of “research,” these audits have returned to haunt us. A lucky 5,000 S Corporations will be selected out of the 3.3 million S Corporations (or one of every 660, or a 0.15% chance). I echo the thoughts of Roth & Company: Please, Mr. Taxman, go somewhere else; Clayton Financial & Tax’s returns are fine (and yes, we’re an S Corporation). Please?