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S-corp Questions
Posted on 6/14/23 at 5:31 pm
Posted on 6/14/23 at 5:31 pm
I'm a sole proprietor and the CPA who prepared my taxes last year said electing as an S-corp was a good idea and would save me a bundle on taxes this year. So I filed Form 2553 before the March deadline and received the IRS acceptance in May.
That said, in reading the IRS explainer quoted below, I see that all gross receipts generated by the shareholder's personal services are wages. And the IRS has the authority to re-classify distributions as wages. My plan had been to take distributions throughout the year, hold the other income in Tbills, and in the last quarter paying myself a reasonable year's salary. But my personal services generate almost all gross receipts. So per the explainer all of the distributions are really wages.
Now I'm questioning whether or not filing as an Scorp is even worth it. Yes, I will likely consult with another CPA. But wanted to check with the geniuses on Money Talk to get some feedback first.
1. Given all of the gross receipts are generated by my personal services, is there any advantage to filing as an S-corp on this years taxes?
2. If not, is there any process required to nullify the S-corp? Would simply not meeting the requirements of an S-corp (e.g., not filing the quarteyl F941s work?
IRS Pub
That said, in reading the IRS explainer quoted below, I see that all gross receipts generated by the shareholder's personal services are wages. And the IRS has the authority to re-classify distributions as wages. My plan had been to take distributions throughout the year, hold the other income in Tbills, and in the last quarter paying myself a reasonable year's salary. But my personal services generate almost all gross receipts. So per the explainer all of the distributions are really wages.
Now I'm questioning whether or not filing as an Scorp is even worth it. Yes, I will likely consult with another CPA. But wanted to check with the geniuses on Money Talk to get some feedback first.
1. Given all of the gross receipts are generated by my personal services, is there any advantage to filing as an S-corp on this years taxes?
2. If not, is there any process required to nullify the S-corp? Would simply not meeting the requirements of an S-corp (e.g., not filing the quarteyl F941s work?
quote:
Reasonable Compensation S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly. The instructions to the Form 1120-S, 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." The IRS has the authority to reclassify payments made to shareholders from non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes). Several court cases support the authority of the IRS to reclassify other forms of payments to a shareholder-employee as a wage expense which are subject to employment taxes.
quote:
To the extent gross receipts are generated by services of non-shareholder employees and capital and equipment, payments to the shareholder would properly be treated as non-wage distributions that are not subject to employment taxes. But to the extent gross receipts are generated by the shareholder's personal services, then payments to the shareholder-employee should be classified as wages that are subject to employment taxes.
IRS Pub
7
Posted on 6/14/23 at 5:49 pm to SaintsTiger
Grey area answer - Give yourself a 45k W-2 and keep the rest as distributions on your GL and dont included them as wages. If the IRS wants to come back and reassign them, go for it, but your chances of getting flagged are relatively low.
That or claim all the income and get punished up front, instead of taking a risk and paying some penalties that can be forgiven for a first time mistake ;)
Anywho, by the book or grey area is up to you
eta: the benefits are that you dont have to pay FICA on the full income and only on the 45k w-2. the rest of the income is taxed at the corp level which may be lower depending on your overall tax bracket
That or claim all the income and get punished up front, instead of taking a risk and paying some penalties that can be forgiven for a first time mistake ;)
Anywho, by the book or grey area is up to you
eta: the benefits are that you dont have to pay FICA on the full income and only on the 45k w-2. the rest of the income is taxed at the corp level which may be lower depending on your overall tax bracket
This post was edited on 6/14/23 at 5:52 pm
Posted on 6/14/23 at 5:52 pm to SaintsTiger
It’s a gray area.
As you said, probably need to talk to a local cpa. Hard to get the kind of details you would need on a message board.
As you said, probably need to talk to a local cpa. Hard to get the kind of details you would need on a message board.
Posted on 6/14/23 at 5:55 pm to Weagle25
quote:He just did. for free
As you said, probably need to talk to a local cpa. Hard to get the kind of details you would need on a message board.
Posted on 6/14/23 at 5:57 pm to ChexMix
quote:
eta: the benefits are that you dont have to pay FICA on the full income and only on the 45k w-2. the rest of the income is taxed at the corp level which may be lower depending on your overall tax bracket
Mostly right but the rest of the income is taxed at the personal level and not the S-Corp level.
Posted on 6/14/23 at 5:59 pm to ChexMix
quote:
He just did. for free
He didn’t give you enough detail to give him a quality answer. Which is why I’m telling him to talk to someone not on a message board.
This post was edited on 6/14/23 at 6:00 pm
Posted on 6/14/23 at 5:59 pm to Weagle25
quote:this is correct for passthroughs like S-corps
Mostly right but the rest of the income is taxed at the personal level
This post was edited on 6/14/23 at 6:04 pm
Posted on 6/14/23 at 6:20 pm to SaintsTiger
Okay, this is good to know. I just thought my CPA might have been way off. There are some capital expenditures and some 1099 contractors who do bona fide work.
Posted on 6/14/23 at 10:52 pm to SaintsTiger
Bruh,
Uncle Sam wants you to pay some payroll taxes…Have your CPA cut you a check every month as a salary…pay the man his due…You determine how much you pay yourself…That’s all that is about. Semantics…play the game. Good CPA should be able to advise you. Somebody gotta pay for all this….Stuff…
Uncle Sam wants you to pay some payroll taxes…Have your CPA cut you a check every month as a salary…pay the man his due…You determine how much you pay yourself…That’s all that is about. Semantics…play the game. Good CPA should be able to advise you. Somebody gotta pay for all this….Stuff…
Posted on 6/15/23 at 4:46 am to OptionRight
quote:
Uncle Sam wants you to pay some payroll taxes
You may want some job income because it affects your eligibility for and amount of social security disability and retirement benefits.
For example, the amount of your retirement benefit is based on a formula that includes your highest 35 years of earnings. If you've worked hard to tamp that number down to avoid payroll taxes, that could cost you in your old age.
Posted on 6/15/23 at 6:31 am to SaintsTiger
A lot of it is going to depend on your income OP. The recommendation is usually to go S Corp if you are over around $125,000 net income to the owner. As said do something like a $50,000 payroll and the rest as distributions.
Generally. Speaking the IRS likely won’t have an issue with this. I do have a family member that the IRS audited over this but they ultimately won, and their income was much greater so I’m honestly surprised. Your income is supposed to be fair market range, so you aren’t supposed to pay yourself $45,000 if you have a $500,000 income and couldn’t reasonably hire someone to do your job (like lawyer) for $45,000.
ETA: I’m not a cpa and some CPA’s already replied so listen to them. I’m just a business owner trying to give you real world advice I was given.
Generally. Speaking the IRS likely won’t have an issue with this. I do have a family member that the IRS audited over this but they ultimately won, and their income was much greater so I’m honestly surprised. Your income is supposed to be fair market range, so you aren’t supposed to pay yourself $45,000 if you have a $500,000 income and couldn’t reasonably hire someone to do your job (like lawyer) for $45,000.
ETA: I’m not a cpa and some CPA’s already replied so listen to them. I’m just a business owner trying to give you real world advice I was given.
This post was edited on 6/15/23 at 6:32 am
Posted on 6/15/23 at 10:53 am to SaintsTiger
Ahhh reasonable compensation... one of the most "gray areas" in the tax code...
Here is how I explain it to clients.
In theory... when you are self-employed, you wear two hats... worker and owner. You should be getting a premium by being an owner and taking that risk, over what you would earn as an employee somewhere else.
In trying to divide the line between owner and employee, I ask the client, if you had to go pay someone else to do the work you are doing, at a reasonable rate, but not any of the administrative stuff you are doing, what would you pay them?
That's your reasonable salary. The rest of your profit is profit distributions which can avoid payroll tax.
The big issue, to be blunt, is there's a whole lot of people out there who are 1099 "self-employed" but actually should be an employee. When you are a 1099 and you do all your work for one "client", I'm sorry, you should really be an employee of that client.
The other consideration is this... it costs money to be an S Corp. Another income tax return, running payroll and payroll tax returns, unemployment coverage, etc. You have to make sure that the payroll tax savings exceed the additional compliance costs, net of deduction.
For that, I don't even really start the conversation until the client has net income before owner comp of at least 100K - 150K, projected for at least two years.
Others have said that reasonable compensation is like obscenity, no one can define it, but you know it when you see it! Or really, you know when you don't see it. I've had a lot of attorneys, for example, call me over the years wanting me to take over their work, S corp, they are the only attorney and they maybe have one paralegal, net income before owner comp of $400K, and insist that a reasonable salary is $35K. That is NOT reasonable.
Here is how I explain it to clients.
In theory... when you are self-employed, you wear two hats... worker and owner. You should be getting a premium by being an owner and taking that risk, over what you would earn as an employee somewhere else.
In trying to divide the line between owner and employee, I ask the client, if you had to go pay someone else to do the work you are doing, at a reasonable rate, but not any of the administrative stuff you are doing, what would you pay them?
That's your reasonable salary. The rest of your profit is profit distributions which can avoid payroll tax.
The big issue, to be blunt, is there's a whole lot of people out there who are 1099 "self-employed" but actually should be an employee. When you are a 1099 and you do all your work for one "client", I'm sorry, you should really be an employee of that client.
The other consideration is this... it costs money to be an S Corp. Another income tax return, running payroll and payroll tax returns, unemployment coverage, etc. You have to make sure that the payroll tax savings exceed the additional compliance costs, net of deduction.
For that, I don't even really start the conversation until the client has net income before owner comp of at least 100K - 150K, projected for at least two years.
Others have said that reasonable compensation is like obscenity, no one can define it, but you know it when you see it! Or really, you know when you don't see it. I've had a lot of attorneys, for example, call me over the years wanting me to take over their work, S corp, they are the only attorney and they maybe have one paralegal, net income before owner comp of $400K, and insist that a reasonable salary is $35K. That is NOT reasonable.
Posted on 6/16/23 at 11:36 am to SaintsTiger
From my experience, any savings from payroll taxes is offset by lost QBID deduction since the S corp's QBID deduction is limited to W-2 wages paid.
Posted on 6/16/23 at 11:37 am to LSUFanHouston
quote:
I've had a lot of attorneys, for example, call me over the years wanting me to take over their work, S corp, they are the only attorney and they maybe have one paralegal, net income before owner comp of $400K, and insist that a reasonable salary is $35K. That is NOT reasonable.
I believe one of the leading Tax Court cases on the personal services compensation issue involved a law firm. IRS loves going after lawyers (Spoiler alert: lawyers lost).
Posted on 6/16/23 at 11:58 am to texn
Your concern about a single earner is legit.
Most of the advice I would give has already been addressed, but I'll add that you can get a reputable reasonable compensation study done for a couple hundred bucks. Check our RCReports. You answer a questionnaire and they provide you with information that you would use to defend yourself if the IRS came knocking.
The benefits are becoming greater at lower incomes since the Social Security tax wage base has increased a lot recently.
2015 $118.5
...
2019 $132.9
2020 $137.7
2021 $142.8
2022 $147.0
2023 $160.2
Most of the advice I would give has already been addressed, but I'll add that you can get a reputable reasonable compensation study done for a couple hundred bucks. Check our RCReports. You answer a questionnaire and they provide you with information that you would use to defend yourself if the IRS came knocking.
The benefits are becoming greater at lower incomes since the Social Security tax wage base has increased a lot recently.
2015 $118.5
...
2019 $132.9
2020 $137.7
2021 $142.8
2022 $147.0
2023 $160.2
Posted on 6/16/23 at 2:37 pm to texn
quote:
From my experience, any savings from payroll taxes is offset by lost QBID deduction since the S corp's QBID deduction is limited to W-2 wages paid.
The limitation is either 50% of that shareholders allocation of wages or the alternative of 25% of wages + 2.5% of the unadjusted basis of qualifying property whichever is larger. So it is really dependent upon type of business. Not sure what your numbers are to lose that QBID deduction. Are you talking about a sole proprietor who makes lets say 150k / yr. Now as an S corp - If you do 60k in wages - 90k flow thru I still would get the max qbid deduction in this scenario.
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