IRS Discusses More Extensive Oversight Of S Corporations As More Officers Underreport Compensation

Arizona’s Top Tax Attorneys Explain The Treasury’s Audit & The Ramifications For Your Corporation

A recent TIGTA audit analyzed whether officers of S corporations were intentionally underpaying themselves in an effort to avoid paying employment tax. As a result, several recommendations were made to the IRS to take further action and identify ineligible S corporations.

What Is An S Corporation?

There are multiple types of business structures available to individuals who are establishing a corporation. S corporation is a structure that is often attractive to small business owners over a standard C corporation because of the tax benefits that it offers. Under S corporation, income and tax losses are passed to the shareholders to claim on their individual tax returns, meaning that the owners of the corporation have limited liability protection so that their own personal assets are protected in case of claims due to litigation or contracts.

When filing their tax returns, owners of S corporations utilize form 1120-S, making them easy for the IRS to identify and examine.

S Corporations Audited By U.S. Department Of The Treasury

An audit that was finalized in August 2021 was initiated over concern that some owners of S corporations were underpaying themselves, or not paying themselves at all, so that they could avoid paying employment taxes. The office of the Treasury Inspector General for Tax Administration (TIGTA) wished to determine whether the policies and practices of the IRS were adequately overseeing these corporations. If S corporation officers choose not to compensate themselves and avoid paying employment taxes, other taxpayers may be burdened by a loss of government revenue and increased strain on services such as Social Security Administration and Medicare.

The audit report from TIGTA indicates that the IRS currently selects less than 1% of all S corporations for audit, despite the known issue of officers avoiding compensation and the resulting taxation. Of the small number of S corporations that are examined, allegedly about half of the IRS agents who are examining the cases do not evaluate the issue of officer compensation, even when there is no compensation reported or when the officers report taking tax-free donations in lieu of compensation from their corporation.

TIGTA analyzed nearly 267,000 S corporation returns, finding profits of $108 billion that were not taxed for Social Security or Medicare. They estimated that nearly $25 billion in unreported compensation also meant that these corporations avoided paying $3.3 billion in other tax contributions.

Additionally, the TIGTA audit identified 151 S corporations who had non-resident alien shareholders. Having non-resident aliens as shareholders not only violated the conditions of an S corporation and rendered them ineligible for the benefits of being an S corporation, but also represented a loss of $5 million of unassessed corporate income taxes had they been audited and correctly filed as C corporations.

TIGTA Makes Recommendations To The IRS

Recognizing the magnitude of this issue when extrapolated across the other 99% of unexamined S corporations, TIGTA laid out five recommendations to the commissioner of the Small Business/Self-Employed Division of the IRS. These recommendations included evaluation of IRS procedures, thresholds, and decision-making policies related to S corporations.

IRS management agreed to only two of these five recommendations. They agreed to issue letters to the 151 S corporations asking them to review their eligibility status and then to re-analyze those corporations again after one year.

The Importance Of S Corporation Compliance

To avoid additional tax liability and litigation, it’s crucial that S corporations carefully examine their eligibility for filing as an S corporation and verify that their internal operations are accurate.

Protect Your Rights With Arizona’s Most Qualified Tax Attorneys

If you’re facing tax court, an audit, or other tax-related litigation, contact Silver Law PLC. Our tax attorneys in Scottsdale are former IRS employees who represent more than 70 years of combined experience navigating tax law. We understand both sides of tax controversies and are ready to represent you. To schedule your consultation, contact Silver Law PLC today.

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