Reasonable compensation, S Corps

[Strongsilence-CPA]

I know this is an issue for the IRS.  And so with each new S-Corp client I start reading some guidance. Then it always occurs to me that my clients are too small to bother the IRS (All are less than $500K sales).  I usually choose an annual wage for the client of about 1/4/ to 1/3 of annual nontaxable distributions then let it go.

How much time do you spend on this issue with your clients?

(I picked up a new Scorp client a week ago who has never paid herself a wage in 8 years who has never been audited.  Her annual sales are usually about $100 to $150K.)

[qbteachmt · Accepted solution]

"that my clients are too small to bother the IRS (All are less than $500K sales)."

How is that "too small" for the IRS?

"I usually choose an annual wage for the client of about 1/4/ to 1/3 of annual nontaxable distributions then let it go."

I usually look to the BLS for job descriptions and pay similar to the type of work and the region; the Job Service has great guidance, as well. That shareholder-employee also knows what that sort of work would pay if they got employed by another, and didn't try to run their own business.

I've also used this material and reviewed their videos:

https://rcreports.com/

[abctax55]

Playing the audit "lottery"  (then it always occurs to me that my clients are too small to bother the IRS) is unwise, and against the various rules governing your CPA license. 

There's voluminous material discussing whether a percentage of gross, or net, or distributions is allowed.  And the material pretty much all says 'nope'.

YMMV - but that doesn't make it correct.  Nor does the fact your new client hasn't been audited.  Yet.

[qbteachmt]

"Playing the audit "lottery" "

And it seems to me that when the S Corp I worked for was subject to BLS reporting, it was for 2 years, and we sure were not at $500,000 sales then. What was fun, though, was when one of the other staff started to complain about needing a raise, I pulled the BLS info for that job title and duties in our region and the statistics on pay packages. I showed him he was positioned just fine. I did not tell him we were the local reporting entity.

[BobKamman]

I had an office neighbor whose entire practice was setting up small businesses as S Corps, then having the owners pay themselves no salary.  And he said he always got away with it.  But that was 15 years ago.  These days, though, there may be enough of those left that IRS will go after those paying no salary, before they go after those paying some salary.  

IRS is never too small to be bothered.  Look at all the EIC audits they do.  On the other hand, there was someone posting recently about the fear of a "hobby loss" audit.  I had a client with losses in the $50,000 range for many consecutive years, and we always had to remind ourselves that all the court cases involved horse breeders with $500,000 losses.  (And some of them won, because the value of their real estate kept increasing and they had to farm to keep the property taxes low.)

Not just S corporations, with a lot of small businesses it's the owner who makes less than the employees.  There is often no comparison because no one would hire them; that's why they created their own job.  And why start with a reasonable salary?  Why not start with a reasonable return on their capital investment?  If anything is left over, that's what they get paid.