Billions of tax dollars lost to no-salary schemes
With two daughters and a wife who have taught elementary school, I learned a shocking thing: There are parents who, even when faced with proof of wrongdoing by their offspring, are certain that it was someone else’s kid.
That isn’t the way I remember things. My mother generally assumed that her only son actually could have been involved. My father knew it.
They say the only difference between men and boys is the price of their toys. It is also the dollar cost of their transgressions.
The Treasury Inspector General for Tax Administration is the principal of the tax school. It seems some tax practitioners have been bad boys.
What did they do? Encouraged or facilitated S corporation owners to underpay themselves. Why would an owner do such a silly thing?
If there is only one owner of the S corporation, he or she reports all of the income on their tax return. This is so whether they pay salary for services rendered or not.
Let’s say your S corporation has a $150,000 profit. You pay zero salary. The income of $150,000 flows to the owner’s return.
Now say you pay $100,000 of salary. The corporate income of $50,000 (you deduct the salary) is reported on your return, as is the W-2 income of $100,000. Two items, same $150,000.
When you pay wages of $100,000, you also pay $7,650 of “FICA” tax. Your corporation also pays $7,650 to Mr. FICA.
With this knowledge you, and the little scamps who have grown up to now be tax advisers, decide to pay no salary. Can you do this?
The rule follower answer is no, you cannot do this if you work for the company. However, you probably won’t be caught if you do.
This is what concerns TIGTA. Our principal thinks the teachers are allowing too many shenanigans to go unpunished. No matter what The Who says, the kids aren’t alright.
Should we just say, “boys will be boys” and let this pass? Well, as astronomer Carl Sagan would have said, had he instead been a tax auditor, there are “billions and billions” of FICA dollars lost each year.
The problem, says TIGTA, is that less than 1% of S corporation tax returns are selected for audit. Even then, less than half the returns audited include scrutiny of officer’s compensation. TIGTA looked at 266,000 S corporation returns that (a) reported $100,000 or more of profits; (b) had only one shareholder; (c) paid no officer’s compensation; and (d) had not been audited.
In total, the returns reported $108 billion of profits, showed $69 billion distributed to the sole owners, but zero compensation and therefore zero FICA tax paid.
TIGTA made five recommendations, three of which related directly to updating the examination plan for low compensation. IRS did not agree to any of those three recommendations.
So why did I start this column with a discussion of tax professionals behaving badly? It may be that we tax practitioners, when behaving ourselves, are the best protection against major transgressions.
Advising an S corporation owner to take “low” compensation may be within the bounds of reason. Zero compensation for a shareholder who works for the business is just wrong. TIGTA says so. Professional advisers should say amen.
It seems that, to date, they have not. Things may be changing, although for the wrong reasons. The tax law now allows a 20% income tax deduction for qualified business income.
For those who make “too much” money, this deduction may be limited, or even lost, if the business pays no W-2 wages. Some S corporations are now paying W-2 wages just to secure this 20% deduction. The math still favors no compensation. A 20% tax deduction saves less (maximum 7.4% for a 37% bracket taxpayer) than the 15.3% combined FICA tax.
The phaseout of this 20% deduction for high-income taxpayers creates the odd math result that the greatest deduction comes if two-sevenths of the income is paid in wages. FICA tax drops from 15.3% to 2.9% above an inflationadjusted wage level. Owners at this limit may get a raise to maximize the 20% deduction. Maybe to two-sevenths of corporate income. Still boys playing a game.