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Lev
Lev, Tax Advisor
Category: Tax
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Experience:  Taxes, Immigration, Labor Relations
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Why S Corp is more taxes Audit risk than C Corp? What are

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Hi, Why S Corp is more taxes Audit risk than C Corp?What are the best tips to avoid them and make everything as organized as possible.

According to the Treasury Inspector General for Tax Administration (TIGTA) - most recent report - when the IRS auditing the returns of S corporations, the number of audits the IRS closes with no recommended adjustments is very high - 62%

https://www.treasury.gov/tigta/auditreports/2012reports/201230062fr.pdf

So far even the IRA audits S-corporation - most such audits are ended with NO adjustments.

There are audits risks with any business form. Typically taxpayers under $200,000 in income face a 1% audit risk. And S-Corporations face a 0.42% audit risk.

While we do not have later statistics - I woudl expect the IRS already adjusted their practice of choosing S-corporations for audit.

There are some sensitive areas for S-corporations during audits:

- Unreasonably Low Compensation when wages are significantly less than other distributions;

- Insufficient Basis for Loss Deductions when losses are passed to shareholders

- Loans to shareholders instead of compensation or distributions which are NOT bona fide loans;

- Ineligible Shareholders that may result in termination of S-corporation status

So far - these are primary areas to address and reduce the audit risk .

Questions?

Customer: replied 1 month ago.
Perfect, thanks for your complete answer... just the las question, if I am the only shareholder in a S Corp (I'm resident), and I will have a 250,000 of profit is better if I pay myself 25,000 a year with w2 and the other 175,000 like a dividends ? how is it more advisable?

The instructions to the Form 1120S, U.S. Income Tax Return for an S Corporation, state "Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation."

There are no specific guidelines for reasonable compensation in the Code or the Regulations. The various courts that have ruled on this issue have based their determinations on the facts and circumstances of each case.

We may not use any specific percentage for allocation and may not consider that as a "save harbor"

There is NO pre-set percentage if that what you are looking.
All depends on circumstances and type of business.

Some factors in determining reasonable compensation (according to the IRS):

  • Training and experience
  • Duties and responsibilities
  • Time and effort devoted to the business
  • Dividend history
  • Payments to non-shareholder employees
  • Timing and manner of paying bonuses to key people
  • What comparable businesses pay for similar services
  • Compensation agreements
  • The use of a formula to determine compensation

In general - we need to consider - if you are working for another company and perform same or similar duties - what compensation you woudl expect?

Lev and 4 other Tax Specialists are ready to help you
Customer: replied 1 month ago.
I'm absolutely are the only owner of the company, I do all the management, taxes, organization and record keeping, I have companys contract me and I sub contracts other people to do the job like a non employees.

I do not think that based on that information I could determine what is reasonable compensation for your services - if that what you are asking...

You might know better what such services might worth.

For instance if you hire someone to do THAT job - what you offer as compensation?