Eighth Circuit upholds ‘Watson’ decision requiring increased comp for CPA S corporation shareholder

February 21st, 2012 by Joe Kristan

The Eighth Circuit Court of Appeals has upheld the widely-discussed Iowa District Court opinion in Watson. The district court required an one-shareholder S corporation owning an interest in a CPA practice to pay employment taxes on about $90,000 of compensation, even though the S corporation issued the shareholder a W-2 for only $24,000. The partnership reported around $200,000 of K-1 income to the S corporation.
This is an extreme example of the so-called “John Edwards Shelter,” where an owner pays less employment tax by earning income through an S corporation than might be paid if the business were reported through a partnership or a Schedule C. It shows that there are limits to how low courts will allow S corporation shareholders to set their compensation; it also stands for the case that a professional business doesn’t have to pay 100% of its earnings as taxable compensation subject to FICA.
I’m tied up with work today, so I will follow up later when I can.
Links:
Eighth Circuit Decision
District Court Decision
Related Tax Update Coverage:
Court sets ‘reasonable’ comp for Iowa CPA S corporation shareholder
What do Newt and John Edwards have in common?

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