Are You a Pig or a Hog?

March 8, 2011 | Subscribe to our RSS Feed

Not to sound like a broken record (do some of you not even know what a record is) since I have written about this before, but a recent court ruling concluded that an S corporation shareholder-employee’s $24,000 salary in 2002 and 2003 was unreasonably low, and allowed the IRS to reclassify as salary over $67,000 in dividend payments to the officer during each of those years. The corporation will also owe employment taxes, penalties and interest on the reclassified distribution payments to the tune of $48,519.

This wasn’t a dentist who pulled this stunt, but rather an accountant.  I know what you are thinking; it wasn’t me.

The Internal Revenue Service is targeting service businesses, such as dental practices, that try to minimize Medicare and Social Security taxes by paying shareholder-employees an absurdly low (unreasonable) salary.  To make up for the low salary, additional payments in the form of shareholder distributions are taken thus avoiding any employment taxes.

The IRS warns S corporations not to attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages.  They consider several factors in determining reasonable compensation:

• training and experience;
• duties and responsibilities;
• time and effort devoted to the business;
• distribution history;
• what comparable businesses pay for similar services;
• use of a formula to determine compensation.

This whole issue revolves around what is reasonable and there is not one pat answer other than, “It depends”.

I know I have said it before, but I will say it again, making me sound like a broken record, “Pigs get fat and hogs get slaughtered”.  Don’t be a hog.

Questions for the Accountodontist?

larry.goldberg@glassjacobson.com