{"id":1119,"date":"2013-10-08T07:23:04","date_gmt":"2013-10-08T11:23:04","guid":{"rendered":"http:\/\/keysolutions.us\/blog\/?p=1119"},"modified":"2013-10-08T07:23:04","modified_gmt":"2013-10-08T11:23:04","slug":"unreasonable-compensation-s-corp-loan-recharacterized-as-wages","status":"publish","type":"post","link":"https:\/\/keysolutions.us\/blog\/unreasonable-compensation-s-corp-loan-recharacterized-as-wages\/","title":{"rendered":"UNREASONABLE COMPENSATION – S CORP LOAN RECHARACTERIZED AS WAGES"},"content":{"rendered":"

Proper tax planning<\/a> and tax preparation<\/a> considerations require that all taxpayers take the necessary steps to properly document their transactions. Failure to document transactions can lead to unintended results with the IRS<\/a>. Taxpayers often fail to take the necessary steps for various reasons, including the belief that they are too busy, will address it \u201ctomorrow\u201d, don\u2019t want to incur a fee to address the issue with their CPA, \u201ceveryone else does it\u201d mentality, believing that the chances that the IRS would challenge this are remote, a total disdain for documentation, or believing that they can correct the situation at a later date.<\/p>\n

Let\u2019s take a peek at a recent court case that discusses what happens when substantiation and documentation are lacking (Glass Blocks Unlimited v. Commissioner<\/i>, Dec. 59,600(M), TC Memo. 2013-180). The president of an S Corp. was its sole shareholder and only full-time employee. In 2007 and 2008, the president transferred funds to his S Corp. to fund its operations. The corporation considered these advances as loans. During these same years, the corporation distributed funds to the president which were not reported as wages or distributions since the president considered these repayments of loans from his company to him. During these years, the S Corp. did not issue Forms W-2, Wage and Tax Statement, Forms 1099-MISC, Miscellaneous Income, or file any Forms 941, Employer\u2019s Quarterly Federal Tax Return. The president did not report the S corporation distributions on either his 2007 or 2008 income tax returns.<\/p>\n

While many a business person would agree that the treatment by the president and his company were proper, the IRS did not concur and found that the payments were wages. The Tax Court agreed with the IRS that the payments to its president and sole shareholder were wages subject to employment taxes, not dividends or repayments of a loan, and that the prior transfers by the president to the S Corp. were capital contributions, not loans. The Court dismissed the taxpayer\u2019s argument that reclassifying the payments as wages would create unreasonable compensation, stating that the issue of reasonable compensation also applies with when determining whether payments are wages or some other type of distribution. The Tax Court cited David E. Watson, P.C. v. United States<\/i>, CA-8, 2012-1 USTC \u00b650,203<\/a>, where a business paid its owner-employee an unreasonably small salary of $24,000 at the same time it distributed more than $200,000 in profits.<\/p>\n

Reading court cases can be very educational and informative as the cases outline what the courts look at in arriving at their decision. The Tax Court considered a non-exclusive list of 13 factors described in Calumet Industries, Inc. v. Commissioner<\/i>, Dec. 46,872<\/a>, 95 TC 257. These factors included: the names given to the evidence of indebtedness; the absence of a fixed maturity date or other characteristics of a loan; the parties\u2019 intent; and the risks to the parties making the advances.<\/p>\n

There were no written agreements or promissory notes supporting the argument that the transfers were loans, the Tax Court stated, and the S Corp. did not report the 2008 transfer as a loan on that year\u2019s return. There was no evidence that the president required interest for the use of the transferred funds, that the S Corp. provided any security on the loan, or that the parties had created a fixed repayment schedule. The Tax Court found that, because the expectation of repayment depended solely on the success of the S corporation\u2019s business, the transfers of funds were a capital contribution, not a loan.<\/p>\n

In summary, looking at the facts of this case illustrates what the IRS and the courts look at and how (and why!) taxpayers need to substantiate their deductions or tax transactions. The next time your CPA asks for an explanation of a transaction, requests what documentation you have to support a transaction, or proposes to make changes to your books and records, rather than finding these as an annoyance, instead thank him\/her for their expert tax guidance.<\/p>\n

Note: <\/b>Because each individual\u2019s and company\u2019s tax situation is different, if you want to learn more about the IRS\u2019s reasonable compensation requirements we invite you to call 610-594-2601<\/a> today to make an appointment at our Exton PA CPA office<\/a> to discuss your situation. You can also schedule a consultation at Click Here<\/a>. To learn more about various tax and business services, visit Tax Preparation Services<\/a> and Small Business Accounting Services<\/a><\/p>\n

Copyright \u00a9 2013 Keystone Financial Solutions, P.C. \u00a0All rights reserved. \u00a0BE SURE TO READ THE DISCLAIMER PAGE: Content in this blog is for educational purposes only and should not be considered as the rendering of tax, legal or investment advice. The publisher of this blog makes no representations as to the accuracy or completeness of any information herein, will not be liable for any errors or omissions, and shall not assume liability for any losses, injuries, or damages from the display or use of this information.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

Proper tax planning and tax preparation considerations require that all taxpayers take the necessary steps to properly document their transactions. Failure to document transactions can lead to unintended results with the IRS. Taxpayers often fail to take the necessary steps for various reasons, including the belief that they are too busy, will address it \u201ctomorrow\u201d, […]<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"_genesis_hide_title":false,"_genesis_hide_breadcrumbs":false,"_genesis_hide_singular_image":false,"_genesis_hide_footer_widgets":false,"_genesis_custom_body_class":"","_genesis_custom_post_class":"","_genesis_layout":"","jetpack_post_was_ever_published":false,"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":"","jetpack_publicize_message":"","jetpack_publicize_feature_enabled":true,"jetpack_social_post_already_shared":false,"jetpack_social_options":{"image_generator_settings":{"template":"highway","default_image_id":0,"font":"","enabled":false},"version":2}},"categories":[3],"tags":[],"class_list":{"0":"post-1119","1":"post","2":"type-post","3":"status-publish","4":"format-standard","6":"category-irs-tax-planning-ideas-tips-news","7":"entry"},"aioseo_notices":[],"jetpack_publicize_connections":[],"jetpack_featured_media_url":"","jetpack_shortlink":"https:\/\/wp.me\/p9W9tf-i3","jetpack_sharing_enabled":true,"_links":{"self":[{"href":"https:\/\/keysolutions.us\/blog\/wp-json\/wp\/v2\/posts\/1119","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/keysolutions.us\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/keysolutions.us\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/keysolutions.us\/blog\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/keysolutions.us\/blog\/wp-json\/wp\/v2\/comments?post=1119"}],"version-history":[{"count":3,"href":"https:\/\/keysolutions.us\/blog\/wp-json\/wp\/v2\/posts\/1119\/revisions"}],"predecessor-version":[{"id":1122,"href":"https:\/\/keysolutions.us\/blog\/wp-json\/wp\/v2\/posts\/1119\/revisions\/1122"}],"wp:attachment":[{"href":"https:\/\/keysolutions.us\/blog\/wp-json\/wp\/v2\/media?parent=1119"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/keysolutions.us\/blog\/wp-json\/wp\/v2\/categories?post=1119"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/keysolutions.us\/blog\/wp-json\/wp\/v2\/tags?post=1119"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}