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TIGTA Says the IRS Should Be Pursuing Taxes From S Corporation Owners

By Joel N. Crouch on September 8, 2021
The tax treatment of compensation to S-Corp owners has reared its head again in an August 11th report issued by the Treasury Inspector General for Tax Administration (TIGTA).   As long as I have practiced tax law, tax treatment of distributions to S corporation shareholders has been an issue with no clear answer.  Not surprisingly, the TIGTA report says the IRS should be doing more to examine distributions to S corporation owners.

The report found that the IRS is selecting less than 1% of all S corporations for examination of compliance with payment of employment taxes.  The report says that even when the IRS examines an S corporation return, most IRS agents don’t request information regarding compensation, even when the S corporation has a sole proprietor who does not report any officer compensation, but instead takes tax-free distributions in lieu of compensation.

According to the TIGTA Report, “[t]he issue of S corporations not paying salaries to officers and avoiding employment taxes has been reported for many years.  IRS revenue agents have the opportunity to assess the issues when examining Forms 1120-S, U.S. Income Tax Return for an S corporation, in the field; addressing the issue more directly by examining it in the IRS’s Employment Tax function; or through Compliance Initiative Projects.”

In its report, TIGTA analyzed S corporation returns filed between 2016 and 2018, where the profits exceeded $100,000, there was a single shareholder, and no officer’s compensation was claimed.  The report found that the IRS did not select over 266,000 of these returns for examination.  TIGTA also found that single-shareholder owners made profits of $108 billion and took $69 billion in the form of a distributions, without reporting they received officer’s compensation for which they would have needed to pay Social Security and Medicare taxes. The TIGTA report estimated 266,095 tax returns may not have reported nearly $25 billion in compensation, allowing business owners to avoid paying approximately $3.3 billion in FICA taxes.

As with every report, TIGTA has recommendations for improving IRS examination of compensation in S corporations.  The report recommends that the IRS evaluate the risk of noncompliance associated with owner compensation in S corporation returns and update the examination plan; evaluate the benefits of using thresholds and criteria in classification guidance; or use compliance results from established workstreams to inform decision-making.

Not surprisingly, the IRS position is that all S corporation flow-through income to a single shareholder providing services through the entity should be treated as compensation subject to FICA taxes; however, the courts have not always agreed with the IRS.   Where an owner takes some compensation as salary and can support the reasonableness of the amount, the courts have generally sustained the taxpayer’s position.   However, as the adage says, “Pigs get fat and hogs get slaughtered,” and a single shareholder S corporation that is not paying any salary may be playing with fire.   In light of the report, now is the time to review and shore up support for S corporation compensation.  Doing so after the start of an IRS examination may be too late.

For questions regarding this blog post or any other civil or criminal tax related matter, please feel free to contact Joel Crouch at (214) 749-2456 or jcrouch@meadowscollier.com.