Preparer penalties regarding S corp compensation

[ACS41]

According to last week's NATP newsletter the head of Employment Tax from the SB/SE Specialty Programs stated IRS will continue and expand upon federal and state partnerships particularly in the QETP (Questionable Employment Tax Practices) Program. He specifically stated that 1120S salaries and the issue of reasonable compensation would be a target and that tax return preparer’s were exposed to penalty assertions if they prepared returns that reflected a “less-than-market” salary for services rendered by small business owners of Sub S corporations.

Many business owners have been willing to "take the risk" of non compliance. I can certainly let clients know the choice of non compliance has been taken out of their hands and will require the preparation of a W3, W2, 941, 940, state unemployment return, etc. Clients are certainly going to be mad at having to pay more taxes and preparation charges. To complicate matters, here in Florida once you file a state unemployment tax return you are required to file one every quarter (even if it is zero) or face an automatic penalty or tax lien which creates an additional business owner responsibility.

The prospect of a large preparer penalty certainly is a big concern.

What are your thoughts?

Thank you.

[jainen]

>>tax return preparer’s were exposed to penalty assertions if they prepared returns that reflected a “less-than-market” salary<<

Circular 230 does not necessarily require the preparer to determine if a salary is "less than market." We must be careful not to bring such an obligation on ourself. Questions like "What were your job duties?" would be risky in that regard. Even something as innocent as "What would you have to pay someone else to do that job?" means we are endorsing a methodology for setting the wage.

Of course, if there is NO wage or only an obviously token one we would have to consider the implications of that. Otherwise, stick to "How did you determine the proper amount of wage?" Document the answer in terms of the client having a reasonable procedure, rather than whether the amount was correct.

[ACS41]

Thank you for your insight. In the case where a stubborn client does not understand (or want to understand) why a zero shareholder salary in a profitable S corp is unacceptable, is it my responsibility to determine what salary to book and prepare the applicable payroll tax returns? According to the NATP newsletter quoted, it seems that what they are "suggesting." I have always tried very hard to educate clients on this issue. However, certain clients refuse to take a salary. Some of these clients pay me very nice monthly accounting fees. I certainly do not want to refuse to prepare the tax return!

[Evan S. Golar]

>>tax return preparer’s were exposed to penalty assertions if they prepared returns that reflected a “less-than-market” salary<<

Circular 230 does not necessarily require the preparer to determine if a salary is "less than market." We must be careful not to bring such an obligation on ourself. Questions like "What were your job duties?" would be risky in that regard. Even something as innocent as "What would you have to pay someone else to do that job?" means we are endorsing a methodology for setting the wage.

Of course, if there is NO wage or only an obviously token one we would have to consider the implications of that. Otherwise, stick to "How did you determine the proper amount of wage?" Document the answer in terms of the client having a reasonable procedure, rather than whether the amount was correct.

What do you do - or how do you handle - an S Corp client (100% shareholder) who has a full time day job and uses the S corp as a side business who knowingly makes out checks from the corporation to pay his home mortgage knowing that it's considered distributions and recognizing that it's taxable income on personal 1040 but refuses to commit to structuring a paid salary to himself for a service business?

[jainen]

>>these clients pay me very nice monthly accounting fees<<

No problem then--any penalties are already covered!

[kcjenkins]

Thank you for your insight. In the case where a stubborn client does not understand (or want to understand) why a zero shareholder salary in a profitable S corp is unacceptable, is it my responsibility to determine what salary to book and prepare the applicable payroll tax returns? According to the NATP newsletter quoted, it seems that what they are "suggesting." I have always tried very hard to educate clients on this issue. However, certain clients refuse to take a salary. Some of these clients pay me very nice monthly accounting fees. I certainly do not want to refuse to prepare the tax return!

Well, the choice under the new rules is that either they pay a reasonable salary, or you don't prepare the return. It's not that you are to determine the amount, but the IRS is going to hit you with serious penalties if you sign a return that does not have a reasonable salary for the stockholders who actually do work for the corp. You may not want to refuse to prepare the return, but you are going to have to decide if you want to get on the IRS 's..t list', as well as paying a penalty? This is a 'meaner, tougher' IRS, and you better know that.

[RoyDaleOne]

"Well, the choice under the new rules is that either they pay a reasonable salary, or you don't prepare the return. It's not that you are to determine the amount, but the IRS is going to hit you with serious penalties if you sign a return that does not have a reasonable salary for the stockholders who actually do work for the corp."

How am I to know what a reasonable salary?

I am not an expert in compensation, or reasonable compensation.

Also, I have no authority to force a corporation to pay any salary, let alone a reasonable salary.

I think the IRS is going no where with this one, unless, the IRS gets Congress to change the laws again.

Now, all of this is just my comments.

[JohnH]

"Well, the choice under the new rules is that either they pay a reasonable salary, or you don't prepare the return. It's not that you are to determine the amount, but the IRS is going to hit you with serious penalties if you sign a return that does not have a reasonable salary for the stockholders who actually do work for the corp."

How am I to know what a reasonable salary?

I am not an expert in compensation, or reasonable compensation.

Also, I have no authority to force a corporation to pay any salary, let alone a reasonable salary.

I think the IRS is going no where with this one, unless, the IRS gets Congress to change the laws again.

Now, all of this is just my comments.

--> Now, all of this is just my comments. <---

Are you hinting that I can't claim I relied upon this advice if I get penalized because I agree with it?

Just want to be sure I understand...

[SunTaxMan]

This thread, to me at least, would seem to be "making a mountain out of a molehill."

Primary concern is whether:

1. S-Corp Shareholder is being paid a wage or not - grounds for refusal to prepare the return? No question. Either taxpayer dot's the i's and crosses the t's, or IRS will do it for them. I don't want IRS doing it for me, I will take care of this myself, thank you! Either cooperate with the wage-paying requirement or look for another Preparer - that's just the way it has to be.

2. Whether the wage paid is "reasonable?" This would seem to be a much wider "target" - since "reasonable" could be a substantial variable and defined somewhat differently be each of us. How do I comply with this requirement? A simple conclusion on my part. Perhaps to document my "conclusion" in my notes as to why the wage paid is reasonable. AND, remembering all the while, that the IRS auditor may not define "reasonable" in the same way I do, or the taxpayer does, for that matter. BUT, if my evaluation is that it is "reasonable," and I can provide reasoning to explain the "reasonableness," what more do I need to do?

[jainen]

>>I have no authority to force a corporation to pay any salary<<

There is no question of forcing the corporation to do anything. Your job is simply to fill out the tax return correctly, whatever they do. But you need to understand what they ACTUALLY do, rather than just what they say. If the distributions actually function as a salary, you must treat them as such.

There is a good example of what I'm talking about in Reg 1.6694-1(e)(2). This is the authority we have to rely on taxpayer's statements without verification unless we know about an error. Even when the code requires specific documentation, such as meals & entertainment, we only need to be "reasonably satisfied by the taxpayer's representations" that the taxpayer has complied, i.e., that the records exist. We do NOT have to determine whether the records are accurate. In the same way, we do not have to determine whether a wage was reasonable, only that the taxpayer has made such a determination.

If the taxpayer is unable or unwilling to provide you the information you need to prepare the return, then you can't prepare the return.

[ACS41]

>>I have no authority to force a corporation to pay any salary<<

There is no question of forcing the corporation to do anything. Your job is simply to fill out the tax return correctly, whatever they do. But you need to understand what they ACTUALLY do, rather than just what they say. If the distributions actually function as a salary, you must treat them as such.

There is a good example of what I'm talking about in Reg 1.6694-1(e)(2). This is the authority we have to rely on taxpayer's statements without verification unless we know about an error. Even when the code requires specific documentation, such as meals & entertainment, we only need to be "reasonably satisfied by the taxpayer's representations" that the taxpayer has complied, i.e., that the records exist. We do NOT have to determine whether the records are accurate. In the same way, we do not have to determine whether a wage was reasonable, only that the taxpayer has made such a determination.

If the taxpayer is unable or unwilling to provide you the information you need to prepare the return, then you can't prepare the return.

If the taxpayer takes zero salary, takes distributions, and is making a profit it seems clear the some of the distributions are in fact salary and W2s, 941 etc need to be prepared. Since I am also acting as the accountant, it will by my role to prepare these filings.

I was finally able to make contact with my tax attorney/CPA associate (55 years experience) this morning. His take is unless there is something "gross" you will not have an IRS issue. He also said it is a real good idea to make sure the S corp pays enough salary to someone that is sufficient to operate the business.

[jainen]

>>some of the distributions are in fact salary<<

Here's some good excuses, though.

1 My wife doesn't draw a salary because she does this as a gift to me.

2 My company provides a public service so I can be considered a volunteer.

3 I have such a great product that it just sells itself. I don't really have to do anything!

4 My skill is so specialized there is no market. Nobody ever gets paid for it.

5 I pay myself at the federal minimum wage rate.

6 I only earn commissions and tips.

7 Since I'm still learning, I treat myself as an unpaid intern.

8 And my favorite (on so many levels): I'm willing to take a chance on being audited.

[kcjenkins]

Yes, and in that last one especially, under the new ruling we can NOT sign the return.

5 is the only one there that I'd be comfortable with, and that only depending on the income involved. Clearly, it's not going to be a problem with a business that is not making a profit, either. But when they are taking money in at a good rate, and taking money out as 'distributions' or 'loans', then there is no way that you can justify a 'no-salary' position, that is for sure.

[So and So]

Hi all. I don't post here very often but I read the posts almost everyday.

I did want to comment on this issue. To me, the IRS is dead in the water on their attempt to penalize a tax preparer for the "owners" not taking a resonable salary. If they do this, they are forcing the S-corp into non-compliance by not allowing them to file a timely return. Then they would want to penalize the S-corp for not filing. But, no preparer can file the return w/o being penalized for filing. It just goes in circles.

If the IRS wants to go after the owners for not taking a salary, so be it. But, they cannot penalize me for preparing the return with true and accurate figures. They cannot make me some sort of enforcer or auditor for them.

Now, I know that in reality the IRS can and does do whatever they want. But, I think this is the flaw in trying to get preparers to enforce what they don't have the manpower to do.

[kcjenkins]

Which is why every single tax professional should be writing to their representatives and making the case clearly about what is wrong with this position of the IRS. So is correct that it is a circular logic here, and that it should not be our responsibility to force compliance onto our clients. At least not with an issue that is so unclear. But still, we do have to think very hard about the situation where there is not even a modest salary, and some income that is taken out.

The IRS position is that in such a case, we can prepare the return, but, we also have to disclose the issue. Ignore that at your peril.

[jainen]

>>they cannot penalize me for preparing the return with true and accurate figures<<

When people learn I prepare taxes, they say, "Oh, you must be good with numbers." I say, no, the numbers are the smallest part of my job because the computer basically handles that. The substance of my work is understanding what number goes where.

Compare this to a client telling me that building model airplanes is not a hobby--I have to tell him that how the tax code characterizes the "true and accurate figures" may be very different from what anyone thinks the law ought to be.

In the same way, the corporation is free to do whatever it wants with its money. But you still have to get the tax return right, which often means a different treatment for any given item of income or expense. In fact, in MOST cases corporate accounting, which typically uses Generally Accepted Accounting Principles (GAAP) or Quickbooks, is different from tax accounting, which doesn't use either. Often state law will require a THIRD set of books (for example, corporations are not allowed to use MACRS depreciation on a California return).

So we add another sentence or two to our engagement letter and the interview takes a few minutes longer. Our fee goes up but we give real value to the client because we know how to handle what is important to the IRS. You can't force your client to issue a W-2, but don't you think they are counting on you to warn them about such serious tax consequences? If the facts and circumstances (as stated by your client) indicate that the distributions function as wages, don't you deserve a penalty if you fail to report them as such?

[Gail in Virginia]

Which is why every single tax professional should be writing to their representatives and making the case clearly about what is wrong with this position of the IRS. So is correct that it is a circular logic here, and that it should not be our responsibility to force compliance onto our clients. At least not with an issue that is so unclear. But still, we do have to think very hard about the situation where there is not even a modest salary, and some income that is taken out.

The IRS position is that in such a case, we can prepare the return, but, we also have to disclose the issue. Ignore that at your peril.

I agree that we need to complain to our representatives, because they are the ones that have initiated this round of preparer penalties. In fact, these tougher standards are designed by congress to generate revenue. So I am not sure that our representatives are going to be very open to changing this, but that is the only way it can be done. IRS has to follow the law.

[kcjenkins]

They will change that particular provision, or ruling, IF enough tax professionals write to them [no emails for this one, use snail mail on real paper] and clearly and politely explain WHY it is not reasonable to require them to do something that they are not in a legal position to do. Believe me, most Reps do not have the least idea how the tax code works, they rely on tax professionals for their own returns, and thus they tend to just assume that the IRS is the right source to make decisions about how to enforce the laws they pass. But if it is explained to them in a calm and logical manner, just WHY a particular rule is not fair, and not workable, they can and have corrected some of them. We have to try.

[jainen]

>>it is not reasonable to require them to do something that they are not in a legal position to do<<

While I often take a contrary position on this forum, in this thread I actually do not understand your argument. What are we not in a legal position to do? Determine whether a wage is reasonable? Nobody is asking for that. Correctly categorize an expense? We do that all the time; it is the essence of our job description.

Keep in mind that although we can generally rely on the client's unverified statements, we must consider the implications of everything we do know. If an S-corp has distributions with nothing designated as wages for an officer (i.e., employee), we must explore the possibility that the distributions are properly treated as salary. If the client can't satisfy us on that point, then let the return sit on the back shelf until the extension runs out.

[kcjenkins]

Read it again: "the head of Employment Tax from the SB/SE Specialty Programs stated IRS will continue and expand upon federal and state partnerships particularly in the QETP (Questionable Employment Tax Practices) Program. He specifically stated that 1120S salaries and the issue of reasonable compensation would be a target and that tax return preparer’s were exposed to penalty assertions if they prepared returns that reflected a “less-than-market” salary for services rendered by small business owners of Sub S corporations. "

Now, my point is that the tax preparer is not capable of forcing a client to take any specific salary, nor is it reasonable to require us not to prepare a return unless the client does pay themselves a salary. That is my only point, Jainen. The return is the owner's, so it's not either fair nor reasonable, IMHO, to require us to fire clients, or get fired by them, because they choose to assert that the amount that they pay themselves is justified. Especially if we happen to agree with them. If we have to disclose the issue, flag it, in fact, that is putting us on the hot seat when the IRS is already easily able to identify the returns, just by looking at line 7 of the 1120S. So it's not reasonable to penalize us for preparing a return that states the truth, that they did not pay themselves a salary, or paid a very small salary. We do our part when we properly fill out the Line 7. The IRS is perfectly capable of then looking at those returns that have what they consider 'problem Line 7 entries'. To apply penalties to us is just an attempt to make us do their work for them. That is not fair, and it's an abuse of power, IMO.

[jainen]

>>an abuse of power<<

IRS doesn't actually have that kind of power and efficiency. They can't say what's reasonable compensation any better than we can. In spite of their new bluster they must continue to accept anything that's more than a token amount, especially if the business profits come from sales or employees other than the owner's personal efforts. So can we, with fairly routine inquiry along the lines I said in my first post.

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>>preparing a return that states the truth, that they did not pay themselves a salary<<

The only truth is that the corporation transferred money to the owner. The preparer must determine how to treat that payment for tax purposes, and that may not necessarily be the same way it is treated on the company's books or for other purposes.

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>>writing to their representatives<<

As for contacting your Congressman, you'll need something more compelling than, "It's not FAIR to hold us responsible for how we report expenses on the returns we sign."

[RoyDaleOne]

Steve Jobs and Warren Buffet salary is $1.00 per year. Maybe we can go with that as a comparison.

[Catherine]

<snip>

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>>writing to their representatives<<

As for contacting your Congressman, you'll need something more compelling than, "It's not FAIR to hold us responsible for how we report expenses on the returns we sign."

But the point is not "fairness", but rather that we, as preparers, have no authority in our client's corporations to authorize - or de-authorize - any one particular treatment of expenses. Our job is to tell our clients what the rules are, and to prepare an accurate return based on what they have chosen to do. We all have clients who take much more conservative stands than they are entitled to, and those who push the edge of aggressive stands. We must make them aware of their rights and responsibilities. But they choose their level of comfort; we are neither their nannies nor their keepers, to choose for them.

If a client came to me with zero salary but large distributions, I would be remiss to not tell that client of the rules and the consequences of breaking those rules. I may choose to decline to prepare the return, or choose to prepare it but add statements etc. But I have NO authority to force this client to change his practices. To then hold me responsible for this person's choices does nothing to advance a goal of accurate and complete reporting for tax purposes. The IRS's job should be to penalize the shareholder not following the rules, and not to penalize the person whose work will bring the case to them! Their job will be made harder if they must wade through poorly-prepared S-corp returns (done either by the shareholder or an unskilled preparer, if no qualified preparer will touch it), looking for no-salary cases.

And that should be an argument that will catch a congresscritter's attention; less money brought in.

Catherine

[ACS41]

Read it again: "the head of Employment Tax from the SB/SE Specialty Programs stated IRS will continue and expand upon federal and state partnerships particularly in the QETP (Questionable Employment Tax Practices) Program. He specifically stated that 1120S salaries and the issue of reasonable compensation would be a target and that tax return preparer’s were exposed to penalty assertions if they prepared returns that reflected a “less-than-market” salary for services rendered by small business owners of Sub S corporations. "

Now, my point is that the tax preparer is not capable of forcing a client to take any specific salary, nor is it reasonable to require us not to prepare a return unless the client does pay themselves a salary. That is my only point, Jainen. The return is the owner's, so it's not either fair nor reasonable, IMHO, to require us to fire clients, or get fired by them, because they choose to assert that the amount that they pay themselves is justified. Especially if we happen to agree with them. If we have to disclose the issue, flag it, in fact, that is putting us on the hot seat when the IRS is already easily able to identify the returns, just by looking at line 7 of the 1120S. So it's not reasonable to penalize us for preparing a return that states the truth, that they did not pay themselves a salary, or paid a very small salary. We do our part when we properly fill out the Line 7. The IRS is perfectly capable of then looking at those returns that have what they consider 'problem Line 7 entries'. To apply penalties to us is just an attempt to make us do their work for them. That is not fair, and it's an abuse of power, IMO.

I agree that the return is the owner's and if the owner does not want to follow our advice we cannot force them. Reading this comment and your original comment are you now saying that the preparer can defend themselves to the IRS by stating we are reporting what actually occured (ie, zero salary)? I send out multiple notices a year to accounting clients articulating this issue. I realize that being tougher with clients is needed, but to what point?

[jainen]

>>Our job is to tell our clients what the rules are, and to prepare an accurate return based on what they have chosen to do<<

In my opinion, our job is to comply with the law which clearly imposes a duty of "due diligence" and avoiding a return "that demonstrates an intentional disregard of a rule or regulation" unless it also contains a disclosure of "a good faith challenge." (Quotes from Circular 230). You may hold a different opinion, which I suppose is why Congress had to establish preparer penalties in the first place.

I agree we can't force the client to change practices, and have stated that agreement at least twice already in this thread. The company can do whatever it wants with its money. The issue is solely how to fill out the tax return, not how to run the business. If they come to me for tax preparation, I must use my best professional judgment in reporting the payments the way that the tax code defines them. There may be some room for the client's preference for a conservative or aggressive stance, but that is limited and certainly doesn't extend so far as reporting distributions without ANY salary. If a client does not care for my professional judgment, why in the world would he ask me to do the return?