Tax Roundup, 9/6/2013: The IRS is losing the S corporation comp war? And Tax Analysts has a history video!

September 6th, 2013 by Joe Kristan

S-SidewalkIf they’re losing the war, I’d hate to see how they’d act if they won. The TaxProf today offers Schwidetzky: The ‘John Edwards S Corp Tax Shelter': Is the IRS Winning the Battles But Losing the War? :

 Arguably, that case has yet to be litigated. But there are two cases where the taxpayer either paid or was supposed to have paid a modest salary, curiously the same amount in both cases, $24,000 per year. The two cases are Watson v. Unied States, 107 AFTR2d 311 (IA DC 2010), aff’d 668 F.3d 1008 (8th Cir. 2012) and McAlary v. Commissioner, T.C. Summ. Op. 2013-62. Both cases rejected the $24,000 salary as too small. But neither case concluded that that the net income of the S corporation was wages. Instead, following John Edwards’ lead, the courts looked to what, essentially, the average similarly situated taxpayer earned instead of what the taxpayer earned from his services…

It is common for tax advisors to suggest that the taxpayer take a salary equal to the social security tax cap. Until the courts come to their senses, there is no reason for tax advisors not to continue to give that advice.

The tax law does not impose self-employment or employment taxes on S corporation K-1 income.  Most (but not necessarily all!) partnership income of active partners, and all Schedule C income, is subject to self-employment tax.  This encourages S corporation shareholders to take less in salary and more on their K-1s.

Mr. Schwidetzky, an academic, seems to think taxpayers are just having their way with the poor IRS, but for those of us in the wild trying to keep our clients out of trouble without wasting their money on excessive taxes, it hardly looks like the IRS is losing.

First, the IRS is auditing S corporations aggressively — way too aggressively.  Mr. Schidetzky fails to bring up the recent Glass Blocks case, where the Tax Court ruled that a struggling one-man S corporation had to pay a “reasonable salary” even doing so throws the corporation into a loss.  That’s a result far worse than the poor guy would have had filing as a Schedule C taxpayer.  It’s hard to see how such pointless and harsh treatment is good policy.

Second, there is still no clear statutory or regulatory guidance to determine minimum “reasonable” salaries.  There are many taxpayers who have interests in multiple businesses, and whose time spent in one of them may be very high early, or when the business may be struggling, but devoted to other businesses in other years.  The taxpayer may take all of his salary from one of his companies, inviting the IRS to say that he should be taking it from other companies instead.  Whatever you do, the IRS can second-guess it, while giving the taxpayer no guidance on what it should be doing.

Third, why is this just an S corporation issue?  The same thing can come up in C corporations.  Think of Warren Buffett’s famous $100,000 annual salary — one that is arguably tens of millions “too low.”  Why not hit him for more payroll taxes?  The same problem can also arise in an LLC with multiple classes of ownership interests in a partnership return.

The “problem,” such as it is, comes from the tax statutes that exempt some business income from self-employment tax, and from the IRS failure to provide clear guidance to either examiners or taxpayers — not from the courts’ attempts to prevent taxpayer abuse.

Related:

 ‘JOHN EDWARDS SHELTER’ TARGETED BY IRS

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

Update: Don’t miss Tony Nitti’s long-form analysis, S Corporation Shareholder Compensation: How Much Is Enough?

 

Lois Lerner, IRS, FEC

Lois Lerner, IRS, FEC

This is why the IRS political scandal is such a big deal.  Who Will Audit the Auditors(Steven Malanga):

The Internal Revenue Service’s targeting of conservative groups has revived old fears about the agency’s vast taxing and auditing powers, so easy to abuse. But the IRS isn’t alone in holding those powers. Across the country, states and municipalities have endowed thousands of revenue and audit bureaucracies with similar capabilities. Critics complain that officials use these entities to harass enemies and help allies. The evidence makes clear just how well-founded those concerns are—especially since these agencies typically receive far less scrutiny than the IRS does.

Using tax laws to silence opposition is a standard part of the Russia and Ukraine dictator toolkit.  And it has happened here, too.   That’s why talk over whether one organization might have had it coming misses the point.  It’s clear that only the Administrations political opponents are getting that sort of examination.  And the IRS can make life difficult even if you are squeaky clean.

TaxProf, The IRS Scandal, Day 120

 

Wall Street Journal,  IRS Rule Leads Restaurants to Rethink Automatic Tips; Gratuities Added for Large Groups Will Be Taxed as Service Charges

 

Starting in January, the Internal Revenue Service will begin classifying those automatic gratuities as service charges—which it treats as regular wages, subject to payroll tax withholding—instead of tips, which restaurants leave up to the employees to report as income.

The change would mean more paperwork and added costs for the restaurants—and a potential financial hit for waiters and waitresses who live on their tips but don’t always report them fully.

Some big restaurants are reconsidering automatic tips on large parties.

 

Answer: the cost, especially when you are young and healthy.  What’s up with Insurance Premiums under Obamacare?  (Kyle Pomerleau, Tax Policy Blog)

 

Roberton Williams, A Closing Window for Some Same-Sex Couples to File 2012 Tax Returns:

But most reports on the ruling have missed an important detail: the IRS will begin applying the new rule on September 16. That gives same-sex couples who haven’t yet filed their 2012 tax returns just a few more days to file as individuals if they choose to do so.

Multiple-sex couples are unaffected.

 

TaxGrrrl, Back To School: Teacher & Educator Expenses 

Russ Fox,  IRS Interest Rates Unchanged for the Fourth Quarter

Kay Bell,  State taxes take a big bite out of most NFL players’ incomes

Paul Neiffer,  Notice to Employees of Coverage Options Due October 1st  More pointless government-mandated busywork for you!

Peter Reilly, Parent Booster Clubs – Raising Money For Your Own Kid Is Not Charity

Steven Olsen,  Tax Court Holds IRS Must Follow Corporation’s Designation on Tax Payment. (Procedurally Taxing):

To pay the restitution for their individual income tax, the Dixons paid the funds to Tryco, and then had Tryco submit payment with Form 941 and a cover letter stating the payment was “to be applied to the withheld income taxes of [the Dixons]” for the applicable years. Initially, the Service followed those directions, and then reversed course and applied the funds to the unpaid employment taxes.

The court held for the taxpayers.

 

Jack Townsend,  Outlier Foreign Investment Conviction

Robert D. Flach has his Friday Buzz on!

 

It’s comical.  Exclusive: Vintage Tax Reform Comic Book Now Online! (Tax Justice Blog)

Christopher Bergin, The Story of Tax AnalystsA little video that tells how this little non-profit has done so much to make the tax law less of an insider’s game.

It’s a little over three minutes, and it would be worth watching just for the old office technology pictured — but it’s especially valuable to see just how far back the IRS desire to hide what it does goes.

Accounting career news. Accounting Career Conundrums: How Soon Is Too Soon to Quit?   Anytime before tax season, if you work for me.  Otherwise, suit yourself.  (Going Concern)

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