IRS Has S-Corps Under Scrutiny

Monday, January 03, 2022

By Susan Kaplan

For years, the IRS has been gunning for a fight with S-Corporations over reasonable compensation. Their guns are now loaded, so get ready, because since 2000 when the IRS established its authority to reclassify distributions as wages and reinforced the employment status of shareholders as employees, it has had S-corps in its sights. Things got serious in 2009, the IRS recognized that reasonable compensation under-reporting was a major compliance issue, and set out to correct it.

COVID brought a short ceasefire. By 2019, examiners were trained to address the long-standing concern over inadequate reasonable compensation and bring S-Corp owners into compliance. Audits picked up momentum, but then COVID hit. So, will the IRS resume its assault on S-Corps and owners’ compensation in 2021? Get ready, because even if the IRS doesn’t show up until 2022, they will likely show up with guns loaded.

The best way to prepare for a reasonable compensation challenge is to be proactive. This means determining reasonable compensation using the IRS’s own criteria and guidelines, not poor past practices.

Advice For Our S-Corporation Clients:

  1. We must compute and document shareholder basis in the S-Corporation each and every year. The TCJA strongly implies that in the case of shareholders claiming a loss, basis be calculated, and in your best interest, Fuoco Group believes this should not be limited to a loss year. It is to an owner’s advantage to be well aware of their basis in their entity. We firmly believe that the honeymoon period is over for S-Corps.
  2. It has long been a requirement that S-Corporation owners need to pay themselves “reasonable” W-2 compensation. Put simply, if you’re making money, you’d better be giving yourself a paycheck. And hidden in the TCJA is a latent license for the IRS to go hunting for this. As your tax advisor, Fuoco Group simply cannot let you ignore this. It needs to be resolved and resolved quickly.

And Some Advice For Our Partnership Clients:

Each year, partner capital accounts have to be presented on a tax basis. Your capital account = your tax basis in the partnership, and the IRS wants to see it. Your Fuoco Group tax advisor CANNOT release the tax return without the calculation.