Warning Sign That A IRS Tax Audit Is Ahead

(or an LLC Taxed as an S corporation)?

IRS has been ramping up enforcement of what is known as “reasonable compensation.” As a shareholder-employee or shareholder-officer of an S Corporation, IRS regulations REQUIRE you to take “reasonable compensation” subject to payroll taxes before you can take any distributions out of your business. Failing an IRS compensation audit means IRS can reclassify ALL distributions as payroll – RETROACTIVELY – and subject you to back taxes, failure to pay penalties, failure to file penalties (for payroll tax forms), interest, and more.

With more than half of the the additional $80-billion of funding provided under the new “Inflation Reduction Act of 2022” passed by the Senate this weekend going to IRS enforcement personnel and activities, IRS will be increasing its efforts to collect taxes from compensation and other audit activities.

Paying yourself as a “1099 Contractor” is not an option IRS allows.

Here is some recent information from one of our professional resources:

“The IRS is deploying technology and big data to combat compensation under-reporting. What does this likely mean for S Corps? That Reasonable Compensation challenges will likely occur outside the traditional exam process. A challenge may come from the ongoing Employment Tax Program or the recently launched CIP.

“The IRS is currently running two specialty compliance programs that target Officer Compensation:

  1. Compliance Initiative Project (CIP): In August 2020, the IRS began its newest CIP targeting non-payment and underpayment of compensation to officers of S corporations.
  2. Specialty Workstream: The IRS’s first CIP to focus resources on the issue of officer compensation was transitioned into a Specialty Workstream under the Specialty Examination Employment Tax Program focused solely on S Corp. officers’ compensation. But it has not gone away.

“It’s no longer the luck of the draw if you get challenged; technology is now zeroing in on officer compensation. Being prepared to defend a challenge is all about being proactive. All S Corp Officers should have credible research and documentation to support their Reasonable Compensation figure. Those that don’t face an uphill battle even if their figure was ultimately determined to be reasonable.”

IRS provides its compensation auditors a 54-page “Reasonable Compensation Job Aid” to help them ferret out targets for reasonable compensation cases. IRS also has a long list of Court case wins that strengthen their position in any challenges.

We can help you head off problems with an IRS compensation audit. Our Compensation Analysis service can help you determine and support your reasonable compensation and head off problems with IRS assessments of back taxes and penalties. Just reach out to us at info@bourbonnaistax.com and we’ll get you started.

NOTE: Reasonable compensation challenges are not just for S corporation owners! IRS has also challenged compensation amounts that are TOO HIGH for C Corporation owners!