The old adage “pigs get fat and hogs get slaughtered” should be considered when setting owners’ salaries for S corporations.  The IRS continues to challenge salary ranges that are not reasonable.  On February 21, 2012, the Eighth Circuit (David E. Watson, P.C. no. 11-1589 8th Cir. 2/21/12) affirmed a decision made by the Iowa District Court regarding an S corporation shareholder’s $24,000 salary.  The District court found that $24,000 was not reasonable compensation and determined a reasonable salary for the owner was $91,044.  The government used an expert witness to determine the reasonable salary.

The common strategy of paying low salaries to S corporation shareholders who provide services to their corporations results in reduced employment taxes.  The Watson case is interesting because it involves a CPA who tried to save payroll taxes by paying himself a small salary.

Watson was a CPA with a graduate degree and had 20 years of experience practicing in accounting.  He formed an S corporation and assigned his ownership in an accounting partnership to his S corporation.  Watson reported all of the partnership income on the S corporation tax return.  The S corporation paid Watson a W-2 for the accounting services he rendered to the partnership.  In 2002 and 2003, Watson received a salary of $24,000 from the S corporation.  He also received a distribution of $203,651 in 2002 and $175,470 in 2003.  The distributions were not subject to payroll taxes.

The IRS challenged the low salary and prevailed when Watson argued against the IRS in District Court.  Watson then appealed the decision in the Eighth Circuit and lost.  Because Watson lost the court cases, he was required to pay payroll taxes on the increased salary plus penalties and interest on the underpaid tax.

The IRS continues to challenge reasonable compensation.   Wallace Neumann & Verville, LLP is fortunate to have Romeo Razi (a former IRS Revenue Agent) who specialized in performing reasonable compensation audits for the IRS.  If you have questions regarding reasonable compensation for your S corporation, feel free to contact Romeo one of our Las Vegas CPAs at Wallace Neumann & Verville, LLP.

Disclaimer

On September 21, 2011, the IRS unveiled a program that allows taxpayers to voluntarily reclassify independent contractors as employees at a significantly reduced employment tax burden, with no penalties or interest. The voluntary classification settlement program (VCSP) is designed to help taxpayers address their tax responsibilities.

The VCSP was designed to encourage voluntary compliance with worker classification rules and is the start of an increased focus on the worker classification issue.  To increase enforcement efforts, the IRS, the Department of Labor, and several states have signed a memorandum of understanding.  This memorandum is designed to strengthen information sharing regarding misclassified workers.

The determination of whether a worker is an employee or an independent contractor is usually based on a multi-factor common-law test that considers the facts and circumstances of the relationship between the worker and the employer.  The primary factor usually revolves around the control that is or can be exercised over the worker.  Since the determination involves facts and circumstances, many times the classification is not as clear cut as one would hope.

If the IRS conducts an audit of this issue and finds misclassifications, the IRS will probably be less willing to negotiate on worker misclassification penalties and interest because the taxpayer had a chance to come forth voluntarily under VCSP and failed to do so.

Since the rules surrounding whether a worker should be classified as an independent contractor or an employee are complex and often difficult to apply, you may consider consulting one of the Las Vegas CPAs at Wallace Neumann and Verville, LLP.

The IRS has a new buyout program that encourages employees to accept early retirement.  Under the new buyout program, about 400 employees are being offered $25,000 to exit the IRS early.  This program is similar to the buyout offer that emerged last November.  The November buyout also promised $25,000 to those that accepted early retirement.

The buyout program has emerged on the heels of reports made to Congress regarding increasing workloads expected from IRS employees just as lawmakers threaten budget cuts at the IRS.   The increasing complexity of the Tax Code, frequent changes in tax laws, and demands for IRS employees to help oversee programs such as the health care reform law have placed a large strain on the Service’s resources.  Currently, it is estimated that the IRS employs approximately 100,000 employees.

For more information, read IRS Offers Early Retirement Buyouts to Employees: Accounting Today.   As always, please feel free to contact your Las Vegas CPAs if you have any questions.

Under the Recovery Act, employers who hired certain unemployed veterans were eligible for a tax credit up to 40% of the first $6,000 (maximum credit of $2,400).  This credit was to expire at the end of 2010.

Last week, the President signed into law two new tax credits for businesses dubbed the “Returning Heroes Tax Credit” and the “Wounded Warrior Tax Credit.”  The credit amounts depend on the amount of time the veteran was unemployed.  Here are the breakdowns:

The Returning Heroes Tax Credit

• 40% of the first $6,000 paid to a veteran that has been out of work for between 4 weeks and 6 months

• 40% of the first $14,000 paid to a veteran that has been jobless for 6 months or more

The maximum amounts for the credits range from $2,400 to $5,600 per newly hired unemployed veteran.

The Wounded Warrior Tax Credit

• 40% of the first $24,000 paid to disabled veterans that have been jobless for 6 months or more

The maximum amounts for the credit is $9,600 per newly hired unemployed disabled veteran.  This is an expansion of the “Work Opportunity Tax Credit” for disabled veterans which used to be capped at the first $12,000 of wages.  This law expands the maximum tax credit from $4,800 to $9,600.

As always, feel free to contact a professional at Wallace Neumann & Verville, LLP for guidance regarding the new business tax credits.