Article Post Date

September 22nd 2011 by Andrew Poulos


As the economy has taken a downturn and tax revenues have declined, Congress and the Treasury Department have put the pressure on the IRS to generate additional tax revenues. As a result, the IRS has issued its opinion regarding higher audit enforcement.

One of the areas of high enforcement is reasonable officer compensation for shareholders of Subchapter S Corporations. This topic is on the IRS hot list because, oftentimes, people misinterpret the Internal Revenue Code (IRC) and Treasury regulations. The code and regulations are vague and don’t clearly define reasonable compensation for shareholders. In other instances, shareholders of S Corporations abuse the law in order to generate a tax savings’ benefit. The consequences of misinterpretation or abuse of the law can be quite costly if a business gets under audit for reasonable officer compensation. The liability can add up to be as much as two to three times what would have been due originally – had reasonable compensation been paid.

Although the IRC does not define what constitutes reasonable officer compensation, it does state that shareholders of S Corporations are included within the definition of employee for FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax Act) and federal income tax withholding. The law requires corporate officers (shareholders) who perform services for the corporation, and receive or are entitled to receive payments, to have their compensation considered wages.

In addition, courts have consistently held that officers/shareholders of S Corporations who provide more than minor services to their corporation and receive or are entitled to receive compensation, are considered employees and the payment is considered taxable for federal employment tax purposes. If this is the case, then why is the law vague as it relates to reasonable compensation? The more the gray area in tax law, the easier it is for the IRS to increase audit enforcement and generate new tax revenues during a challenging economic environment.

This article was provided by Intuit ProLine News Central

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