anyone operate as a sub S corp

[cherokee235]

I just had a long conversation with my accountant about my 1120s return. There is a real concern over my w2 salary for the shareholder employee (SE) and the amount of residual profit left over after all deductions. In the past I have paid myself what I consider a reasonable salary to manage the carwash. If I tried to find someone to do the stuff I do at my pay I'd have dozens apply. Some years if I didn’t buy much equipment I would take a distribution of previously taxed profits. Some years I didn’t distribute as I used the cash to purchase equipment. I’ve never shown a loss.

The IRS is getting really nasty with Sub S Corps about low salaries and high distributions. I’ve done lots of searching on the web and read some tax court cases and the taxpayer has lost every round. The IRS would like to see 100% of the profits subject to FICA regardless what the SE is paid in salary.

This high audit interest started when it was disclosed during the 2004 campaign that John Edwards paid himself about $30k in salary and had over $4 million in sub S bottom line income. Obviously, his salary was unreasonable. Now, the search is on and the Treasury is finding lots of abuse.

There is some argument in capital intensive businesses to accumulate profits to purchase equipment. The carwash business may qualify as such. We buy equipment, use it a few years, save our coins and replace it. In John Edward’s case, he was service oriented and all fees required his participation.

We are a service business with lots of capital assets that don’t require 100% participation to generate income. The business collects money even when we aren’t there. However, there is no hard, fast rule as to how much to pay the SE and how much you can keep back, nor what is appropriate to distribute if any money is left over and not used.

Are any of you who operate as a sub S corp dealing with this problem? If so, what have you learned?

 

[Earl Weiss]

Not sure I understand the problem. If you are a Sub S corp the profits flow thru to the shareholders and are taxed as income. So, you either pay the tax on salary income or profit income. Now if there is an issue with soc sec and unemployment taxes, perhaps that would be a concern, but i think you max out at a certain salary level anyway. Not sure what it is but perhaps it is because it may be the level I am at. There may be other ways to skin the cat. Do you own the land? Does your operating entity pay rent to the entity that owns the land?

 

[Red Baron]

I'm a sub-S and have been told I need to convert to LLC or LLP. May get around to that this year.

Group member Kenny Cox is a CPA; maybe he can shed some light on this.

 

[Earl Weiss]

I'm a sub-S and have been told I need to convert to LLC or LLP. May get around to that this year.

Group member Kenny Cox is a CPA; maybe he can shed some light on this.

Anyone say WHY you need to convert. Have heard this but never heard a good reason yet unless the netity was owning real estate.

 

[cherokee235]

The problem is: the pass through income has no FICA or FUTA paid on it and the IRS has a problem with that. A 2005 study shows a FICA collection loss of over 6 billion a year and over the past 10 years has seen a huge increase in Sub S Corp elections and a decrease in C corp operations, so the business format is very popular.

If you take w2 wages of say, $50k and have an ordinary business profit of
80k on the 1120s, you paid FICA on the 50k and FUTA on the 1st $7000. However, the total income to you the SE (shareholder employee) is 50 + 80 = 130.

You show 50k on the front page of your 1040 via a w2 from the S corp and 80k on Schedule E of your 1040 (income from S corps) via a K-1 from your S Corp.
You really made 130. The gov't sees a huge loophole of uncollected FICA.

Think of it this way: If I operated as a schedule C sole proprietor, 100% of my profit requires 15.3% FICA to be paid. This is the argument that is grabbing hold in the IRS. In the 50, 80 example above you would have paid 80k x .153 = $12,240 extra in FICA tax. See the rub?

An LLC pays FICA on all its income just like a sole proprietor. There are some exceptions to certain limited partners and I'm not real knowledgeable about it.

Yes, my land is owned by a different entity and I will be raising the rent, but it can't be above the prevailing market rents. I don't believe a business should ever own its buildings and real estate if possible. That really complicates things.

 

[Earl Weiss]

OK Cherokee, got it, but isn't there a point where the Slaried individual maxes out on the FICA?

 

[pitzerwm]

Probably not in the near future.

 

[Washmee]

OK Cherokee, got it, but isn't there a point where the Slaried individual maxes out on the FICA?

The Center on Budget and Policy Priorities states that three-fourths of taxpayers pay more in payroll taxes than they do in income taxes.[5] The FICA tax is considered a regressive tax on income (with no standard deduction or personal exemption deduction) and is imposed (for the year 2009) only on the first $106,800 of gross wages. The tax is not imposed on investment income (such as interest and dividends).

http://en.wikipedia.org/wiki/Federal_Insurance_Contributions_Act_tax

 

[Jim L.]

Before changing your ‘S’ corporation you may want to consider a second opinion. I’m a firm believer in “if it ain’t broke…don’t fix it”.

I’ve had my ‘S’ corporation since 1998 and my CPA has never mentioned anything about changing it. I’ll question him this year at tax time.

 

[cherokee235]

OK Cherokee, got it, but isn't there a point where the Slaried individual maxes out on the FICA?

My bad. The social security does max out on the $106k, so my math in the earlier post was not right, but the 2.9% medicare tax is not limited. In my 50/80 example the FUTA would be paid on the 1st $7000, FICA/medicare would be paid on 106,800, and an additional medicare tax on 130,000-106800

Do a google search on "subchapter S corp officers salary" and you will find tons of CPA journal stuff on the "land mines" some small business owners are facing.

I'm really surprised more don't know about this. My CPA has been telling me to be careful about this for 4 years now.

The problem is that all the tax court cases I've read have dealt with service type organizations such as an accountant, lawyer, or doctor who must personally perform the service to make income. Carwash, laundromats don't fit that category. We are mechanics with a few extra marketing and bookkeeping skills. Our machines make income when we are not there. There is no guideline for a reasonable salary other than the argument that if you were a sole proprietor or LLC (depending on the partnership agreement) 100% of the business income subject to the max limits above requires FICA to be paid.

 

[Earl Weiss]

been an S since 1987. Actualyy in 4 S corps and a couple of Cs + 2 LLCs

 

[pitzerwm]

of course its probably too late for some of you but one option that I always used was to own all assets that I could, land, building, equipment and then lease it back to the corp. There are no payroll issues with rental income. When I go audited once, he bitched about the amounts of the rents, I just told him to go for it, I knew the law as well as he did. You can also pay yourself a management fee, rather than salery, they really love that one, but as a C corp, its totally legal.

 

[Waxman]

as a corp. theres no reason you cannot rent the property to the carwash business. there are tax consequences upon selling i believe.

 

[cebo]

I have 2 S corps and my CPA told me to at stay at least 50 / 50 on the salary and business profit in my appraisal business since I am essentially the lone employee. I have another with a partner - just buy and sell real estate. We have never paid any salary and have pass through cap gains (long & short). Been doing this since 1998 with no problems, but with the IRS who knows. I have been wondering for several years what's the difference between an s and an llc but nobody can seem to be specific.

Bill, thanks for the tip on the management fee. I've been stuck in an inherited C (on the car wash) due to carry foward NOL's I can't afford to lose. I'll look into that.

 

[Earl Weiss]

I have been wondering for several years what's the difference between an s and an llc but nobody can seem to be specific.

.

Consult the CPA for more specifics. Tax treatment by the IRS for certain losses can flow thru to "Members" of an LLC but not to Shareholders of a corp. These types of losses primarily affect ownership and operation of real estate as opposed to buying and selling real estate.

Here's the basics based on Illinois structures but it is likely very similar across all 50 states.Structuraly they are different in that LLcs have members who own % interests and Corps have Shareholders who own shares of stock.

Corps are managed by having shareholders elect directors who in turn elect officers who normal decision making authority. LLCs can either be managed by the members or by Managers who are designated and elected by Members thru the LLC operating agreement.

You need to consult with a lawyer and CPA because CPA's are only concerned with tax treatment. Lawyers are also concerned with insulating you from liability. CPAs may recomend using your Social Sec. # for an LLC . A lawyer would not. It is a little simpler for tax prep, but destroys the seperateness as an element of liability seperation.