Feature:
IRS Eyes S-Corporation Oversights

The IRS is finding a lack of documentation in its audits of S-corporations. This lack of proof is making for easy wins for the IRS. What are these oversights and what can you do about it? For the top 10 IRS focus points read on!

First, the largest issue is the small businesses who want to be s-corporation, but never make the request and file Form 2553. Form 2553, Election by a Small Business Corporation (Under section 1362 of the Internal Revenue Code), must be filed within 75 days of the business beginning or of the date the business would like to be treated as an s-corporation. If you missed the deadline you have some recourse with Revenue Procedure 2007-62 which provide guidance for first year in business corporations.

Second, be certain you are not commingling business and personal assets. All business assets must be titled in the business name, especially if you are depreciating them. This also includes the s-corporation should not be paying personal bills or expenditures of the owners. Commingling personal and corporate assets might not be a good idea if you want the legal protection of your corporation too.

Third, one of the s-corporation tax attractions are distributions are generally not subject to a dividend tax and the income earned to generate the distribution is not subject to self employment tax. However, following most corporate governance rules equity distributions require authorization by the Board of Directors (Board). Be certain to have your corporate meetings and follow your corporate governance to avoid these costly mistakes and risky positions.

Fourth, keep up with corporate minutes. At a minimum have annual minutes, but you may want to meet throughout the year (monthly or quarterly) with your Board and management team.

Fifth, pay your annual Secretary of State fee. Consequences of not doing so can terminate your corporation’s existence.

Sixth, basis must be tracked and reported on tax returns in order to claim losses from an s-corporation. The IRS continues to stress that simply guaranteeing a debt of the s-corporation does not increase basis. If the owner does not have basis then distributions could be subject to the dividend tax and losses would not be currently deductible.

Seventh, loans to and from owners require documentation. Loan documentation usually includes the date, borrower, lender, amount, interest rate, collateral (including personal guarantee) and payment terms. If you think you will have an interest rate of 0% you can, but for tax purposes you must impute interest.

Eighth, compensation to officers must be adequate. Generally speaking officer compensation should be equal to or greater than the distributions taken. To determine reasonable officer compensation you will need to take into consideration the business performance, the role the owner is participating in, compensation of other key employees and the fair market value of the owner’s services (i.e. how much would you have to pay another employee for similar services?).

Ninth, employee benefits for greater than 2% owners must be reported on the owner’s W-2. This includes HSA contributions and health insurance paid by the business.

Tenth, unreimbursed expenses cannot be deducted on Schedule E directly against income or losses. This is only allowed for owner in which are taxed as partnerships. For s-corporations, any unreimbursed expenses must be filed on Form 2106.

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Mark Wyssbrod is the Managing Member of Pro @ctive CPA and CEO of Pro @ctive Updates Pro @ctive CPA. Mark has been helping small businesses achieve their goals since 1999. You can reach Mark at (770) 664-8583.

IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.