S-Corp distribution tax rate

[spiritrider]

he said they are unlikely to come after you if a CPA files and beyond that, they'll just tell you to remedy it if it even happens (they "threaten" you).

It is a myth that mere filing with a tax preparer reduces your chance of adverse action from the IRS. Any reduction in risk is based on the premise that they are competent and would not knowingly put their signature on any tax return constituting tax evasion.

One has to question the expertise of your "tax friend". Do they actually have relevant knowledge, skills and experience in an S-Corp 2% shareholder-employee's reasonable compensation. There are many areas of tax law and many are specialists in irrelevant areas.

If they did, they would know that if the IRS determines you paid yourself unreasonably low compensation. There is a 100% penalty on the underpayment of FICA taxes.

Reasonable compensation is definitely a gray area and differences of opinion exist. While you generally have to be greedy to attract the attention of the IRS. There are many inadvertent ways to have your number come up. There are far less gray areas on enforcement policies and procedures.

[GastroMastro]

While I generally agree with jfoxcpacfp, I would lean on the facts and circumstances a little more. The fact that you went from an associate to a partner indicates a more senior position. Where you might have received a merit pay raise even if not made a partner.

The IRS and recent court cases on reasonable compensation do place a strong emphasis on what someone with your knowledge, skills and experience would make in your COL area. However, just leaving it at that one fact and circumstance misses other facts and circumstances.

They have also indicated that a self-employed individual may have other (management, marketing, financial, etc...) responsibilities requiring additional compensation. Therefore, consider your prior W-2 wages as not necessarily reasonable compensation.

While only you and/or a professional can fully appreciate your facts and circumstances. A reasonable compensation of a nominal 5% - 15%% higher than your W-2 wages, might be appropriate.

Personally, I don't understand when people pick exactly the minimum reasonable compensation (2020 = $154K) necessary to maximize one-participant 401k annual additions (2020 = $58K). They can't pay themselves $160K to not be so obvious what they are doing.

I might be inclined to do something similar here. I might pay myself at least $35K/month * 12 = $420K/year to show a small bump as partner. The extra ($20K * 3.8% = $760/year) is not going to break you and you are still saving $480K * 3.8% = $18,240/year.

well phrased, and thank you. i agree it makes sense to bump salary at least a little bit. one can argue if the IRS will call my bluff on going from 400 to 420. but it's not like my hours or work productivity are any different between associate and partner. everything is exactly the same. i go to the physician meetings as an associate, i just would now be able to vote as a partner. everything else is the same.

[Cool Breeze]

It is a myth that mere filing with a tax preparer reduces your chance of adverse action from the IRS. Any reduction in risk is based on the premise that they are competent and would not knowingly put their signature on any tax return constituting tax evasion.

One has to question the expertise of your "tax friend". Do they actually have relevant knowledge, skills and experience in an S-Corp 2% shareholder-employee's reasonable compensation. There are many areas of tax law and many are specialists in irrelevant areas.

If they did, they would know that if the IRS determines you paid yourself unreasonably low compensation. There is a 100% penalty on the underpayment of FICA taxes.

Reasonable compensation is definitely a gray area and differences of opinion exist. While you generally have to be greedy to attract the attention of the IRS. There are many inadvertent ways to have your number come up. There are far less gray areas on enforcement policies and procedures.

I don't necessarily know what to believe, but this particular cpa used to work for the IRS itself - so there's that (and why said person is so confident). Still on other issues the person isn't confident, which is curious and amusing to me, like in the out of state corporation example I gave. Is that scenario (live in one state, incorporate in another) uncommon for telemedicine or other business parties? I'm the single owner/employee in this case.

[jfoxcpacfp]

I don't necessarily know what to believe, but this particular cpa used to work for the IRS itself - so there's that (and why said person is so confident). Still on other issues the person isn't confident, which is curious and amusing to me, like in the out of state corporation example I gave. Is that scenario (live in one state, incorporate in another) uncommon for telemedicine or other business parties? I'm the single owner/employee in this case.

CPAs/EAs who used to work for the IRS and use that as their calling card have a very narrow specialty. You are buying them to assist in the event of an audit. You are not buying them for their broad knowledge and experience. Look up the stats on how likely it is you’ll be audited and decide if you are making a fair exchange. When it comes to tax, practice, employee, etc. advice, everything is NOT a nail.

[Tim]

Not near the expertise of Johanna of Spiritrider.
1) Sounds like for income tax purposes you are claiming state status the some income is earned out of state. You need to document that. A registration of a corporation does not accomplish that.
2) You are talking income tax. You know that "income tax free state"? There are other taxes. Franchise tax for example. Since you now claim to do business out of your "home state" that leaves you with another tax. Did you file franchise tax? What was your "business" in the state, are you registered to do business, where do you do business and have you filed all the appropriate tax forms.

The point is with taxes playing a shell game usually leads to penalties, if not worse. I would NOT rely on an IRS past employment as competent advice. You articles of incorporation is not compliance.

[zlandar]

Has the IRS ever pursued docs for giving themselves an "unreasonable" salary when the salary is well-above the FICA limit of $137k?

I have used the most recent Medscape average salary +$25k as a guideline to set the base salary for the partners in my group.

[Gamma Knives]

The question I have regarding the LLC/S Corp part is incorporating in a great business state and sending yourself distributions (as per usual) to yourself in the residence state. He said this is complicated and seemed more tax attorney type stuff, but I fail to see any issue if the states in question are no income tax states (ie, they don't care or wouldn't be definition come after you). The reason this might be important would be if you live in a state where businesses are taxed, so the corporation is thus elsewhere and the distributions are sent to you, but that's personal income and in the no income tax state, goes untaxed. Feds get what they get, no one otherwise knows or cares. Don't a lot of people do this already? The accountant in question acted like you needed some ID in the incorporated state but I thought that's what registered agents are for, they are quite well advertised everywhere.

Thanks if you can shed light on this topic.

Are you talking about a business that is doing business in the state you reside (such as a medical practice)? You would need to check your state's laws. However, I'm pretty sure your state is going to collect on business done in their state (regardless of where you incorporate). Likely different if it is an online only business. For a physical medical practice, I think incorporating in another state will likely just increase your complexity and possibly expense.

[jfoxcpacfp]

The question I have regarding the LLC/S Corp part is incorporating in a great business state and sending yourself distributions (as per usual) to yourself in the residence state. He said this is complicated and seemed more tax attorney type stuff, but I fail to see any issue if the states in question are no income tax states (ie, they don't care or wouldn't be definition come after you). The reason this might be important would be if you live in a state where businesses are taxed, so the corporation is thus elsewhere and the distributions are sent to you, but that's personal income and in the no income tax state, goes untaxed. Feds get what they get, no one otherwise knows or cares. Don't a lot of people do this already? The accountant in question acted like you needed some ID in the incorporated state but I thought that's what registered agents are for, they are quite well advertised everywhere.

Not exactly or everyone would be doing this. You will have to file as a foreign entity in the tax-friendly state and also in your state. For example, whether or not you live in CA, if you work there, you’ll owe at least the minimum $800/yr state entity tax.

[Cool Breeze]

Just for fun let's use this example. Maybe you already had an out of state no income tax no corporate situation for your LLC, or you create one, whatever. You move to Nevada. You pay yourself a salary from the LLC, that's income, Nevada doesn't have income tax, they don't care. Neither does the LLC state. How would anyone know?

Now, let's use the different example (apparently true from my research) that you have that same LLC out of state, but NV does take a tax out on 4 million gross revenues in its state. Apart from the fact that this might scare people because it's such huge money and they might think NV would go looking if this were the case, you are just living in NV anyway, no one files, how would anyone know? I don't think the federales care as long as you are paying them their yearly cut for S Corp/personal salary etc. Again, you don't even file a state income tax so how would anyone even know or care?

I think a lot of these no income tax pro business states DO get taxes on real estate transfers (like Wyoming, Washington, Florida, etc) so that's why they might be ok with anyone incorporating there.

[Cool Breeze]

Are you talking about a business that is doing business in the state you reside (such as a medical practice)? You would need to check your state's laws. However, I'm pretty sure your state is going to collect on business done in their state (regardless of where you incorporate). Likely different if it is an online only business. For a physical medical practice, I think incorporating in another state will likely just increase your complexity and possibly expense.

It's more like this conundrum of doing telemedicine. If you are paid a salary by an LLC, and the rest is distributions in a no income tax state, how can they say deserve a cut?

[jfoxcpacfp]

They know because those who file 1099s and W2s and give you a copy also provide one to the relevant states. Give them some cred.

>>If you are paid a salary by an LLC, and the rest is distributions in a no income tax state, how can they say deserve a cut?<<

It’s called legislation (aka tax law) and the word of the day of nexus lol. Give them more cred. States that haven’t caught up eventually will catch up. Please trust me on this.

fwiw, NY and CA are the sharks when it comes to nexus and you are the chum.

[Gamma Knives]

Just for fun let's use this example. Maybe you already had an out of state no income tax no corporate situation for your LLC, or you create one, whatever. You move to Nevada. You pay yourself a salary from the LLC, that's income, Nevada doesn't have income tax, they don't care. Neither does the LLC state. How would anyone know?

Now, let's use the different example (apparently true from my research) that you have that same LLC out of state, but NV does take a tax out on 4 million gross revenues in its state. Apart from the fact that this might scare people because it's such huge money and they might think NV would go looking if this were the case, you are just living in NV anyway, no one files, how would anyone know? I don't think the federales care as long as you are paying them their yearly cut for S Corp/personal salary etc. Again, you don't even file a state income tax so how would anyone even know or care?

I think a lot of these no income tax pro business states DO get taxes on real estate transfers (like Wyoming, Washington, Florida, etc) so that's why they might be ok with anyone incorporating there.

The argument that a state entity won't know is a red flag for me. It suggests that if they did know you would be liable. This sounds like tax evasion.

I'm not an expert but would recommend discussing any such action with an expert. I would expect an important distinction is where you are doing business determines tax liability rather than where you are incorporated.

[Cool Breeze]

The whole idea of management of the tax law is the basis on legal tax avoidance, of course, not necessarily evasion. I know the default is to suspect someone is being sketchy but I have honest questions that seem reasonable and doable, beyond that. That's the basis behind "reasonable salary" as well, and while no one wants to be flagged or explain anything to the tax authorities, the decision isn't clear cut and thus people have to make a decision based on various sources and let's face it, risk assessment. Having said that, the idea that a state won't know is just part of risk assessment, not necessarily shady behavior - they are the entities, after all, that legislated that they aren't trying to get (income) taxes from individuals. Let's say you are a telemedicine doc and your best info is that the state you work in (let's just forget nexus for a second and all that argument) is your state of income tax. I'll give another example I have read about. Apparently Tennessee has business taxes. If you are a single member llc, why wouldn't you form a corporation in a no income tax state, pay yourself a reasonable salary, no income tax in tenn, then receive distributions from the company. As fox said before, yes I imagine you have to designate as a foreign entity, but how is any of this illegal? You are your own payer and distributer, no 1099 or w2 from outside. You pay the feds what they ask for and require, etc.

[jfoxcpacfp]

While I generally agree with jfoxcpacfp...

Unanimous agreement is overrated (and kind of boring), don't you think?

[Tim]

The whole idea of management of the tax law is the basis on legal tax avoidance, of course, not necessarily evasion. I know the default is to suspect someone is being sketchy but I have honest questions that seem reasonable and doable, beyond that. That's the basis behind "reasonable salary" as well, and while no one wants to be flagged or explain anything to the tax authorities, the decision isn't clear cut and thus people have to make a decision based on various sources and let's face it, risk assessment. Having said that, the idea that a state won't know is just part of risk assessment, not necessarily shady behavior - they are the entities, after all, that legislated that they aren't trying to get (income) taxes from individuals. Let's say you are a telemedicine doc and your best info is that the state you work in (let's just forget nexus for a second and all that argument) is your state of income tax. I'll give another example I have read about. Apparently Tennessee has business taxes. If you are a single member llc, why wouldn't you form a corporation in a no income tax state, pay yourself a reasonable salary, no income tax in tenn, then receive distributions from the company. As fox said before, yes I imagine you have to designate as a foreign entity, but how is any of this illegal? You are your own payer and distributer, no 1099 or w2 from outside. You pay the feds what they ask for and require, etc.

The point missing is that it is your responsibility to pay taxes. Fully and completely. Your definition of risk assessment is the premise of not getting caught. That is not your responsibility. Your responsibility is to file, declare and pay every tax. The absence of that is tax evasion. Pure and simple.

The point is go ahead and research it or pay someone to find the requirements and implement it. That is why a good tax attorney, structuring and filing is so expensive.
Hope not getting caught is not the same. Nothing personal, just a clarification of your responsibilities. Pay only the taxes due. It is NOT risk assessment, it is your responsibility. Nothing personal intended, just clarifying how voluntary tax filing places 100% of the responsibility upon you. You have to "prove" you did everything correctly. The burden of proof is on you, not the taxing authority.