One of the most significant issues facing S Corporations is whether they pay their shareholder-employee(s) a reasonable compensation. Unfortunately there is no definition of “reasonable compensation” in the Internal Revenue Code or IRS regulations. Thus when reasonable compensation is being discussed in relation to tax preparation or tax planning strategies, tax professionals generally look at court cases for guidance. The recent court cases of Glass Blocks Unlimited (T.C. Memo. 2013-180) and Sean McAlary Ltd. Inc. (T.C. Summ. 2013-62) provide such guidance.
If the IRS is successful in reclassifying distributions and loan payments as wages, not only are there payroll taxes due, but also the interest and penalties associated with the failure to timely remit the payroll taxes.
In Glass Blocks, the court agreed with the IRS that the payments made to the shareholder-employee were properly reclassified as wages rather than as distributions and loan repayments. Although the shareholder had made payments from his personal financial resources to keep the company afloat during the lean years, the IRS found that those payments were capital contributions to equity and not a business loan. The court focused on four factors [Read more…] about HOW TO AVOID IRS ASSESSMENTS – S CORP SHAREHOLDER-EMPLOYEE NEEDS TO BE PAID A REASONABLE COMPENSATION