By Jack Salewski, CPA, CGMA & Paul S. Hamann

Calculating Reasonable Compensation for an S Corp; C Corp; Small or Closely-Held business owner is not just about making the IRS happy.  There are many unintended consequences of not having reasonable compensation. They can be broken down into current; long-term; valuation; entity choice; and preparer issues. We will discuss the current and long-term issues here and follow up next month with valuation issues; entity choice; and the potential impact on the tax preparer.

Current Issues: The Obvious

The most common issue with an unreasonably low (S Corp) or unreasonably high (C Corp) compensation figure is exposure to an IRS Reasonable Compensation challenge.

S Corp: Owner-employees, who miscalculate their compensation too low, risk being required to pay additional payroll tax, penalties, and interest at the federal level.  These additional taxes, penalties, and interest can be double what the cost would have been if reasonable compensation was paid in the first place.  Add onto that cost – additional state payroll taxes; unemployment taxes; workers compensation insurance and their associated penalties and interest, and the costs jump again.  Like a bad, late-night infomercial: “But wait, there’s more”: The IRS usually looks at 2-3 years at a time; now the costs just doubled or tripled.  “But wait there’s even more…”:  Don’t forget the cost of paying an accountant to prepare amended payroll reports, W-2Cs; W-3Cs, tax returns, and the possible costs of a lawyer to defend the taxpayer.

C Corp: The Reasonable Compensation issue is reversed.  The IRS will want to make sure the owner-employee compensation is not unreasonably high. If they prevail, the overstated wages will be reclassified as dividends. The dividends are now taxable to the shareholder, but not deductible by the corporation.  Again, the IRS usually looks at 2-3 years at a time; the cost of paying an accountant; an attorney etc…

Current Issues: The Over-looked

Retirement Benefits: A miscalculated Reasonable Compensation figure can put a taxpayer’s retirement plan, (SEP, 401(k) or a defined benefit plan), out of compliance. The penalties for being out of compliance with a retirement plan will make other penalties look insignificant.  The IRS reference material on reasonable compensation states, “A Reasonable Compensation issue that includes an adjustment of a pension and profit sharing deduction requires a referral to employee plans.”

“S” Corporation Election: If the taxpayer has two or more shareholder-employees and the IRS determines that the owners have been paid unreasonably low compensation, the ensuing reclassification of distributions as wages will result in disproportionate distributions.  This could cause an involuntary revocation of the “S” election.  It may be possible to have the “S” election reinstated,  but not always; this is a situation no one wants to be in.  An involuntary revocation of an “S” election will usually be a financial disaster.

Long Term Issues:

Disability Insurance: Most disability insurance policies are based on earned income.  Understated wages reduces disability coverage.  If any of the shareholders become disabled, there may not be enough cash flow from the disability policy to pay the shareholder’s needs.  This same issue applies to Social Security disability. This is a situation one of the authors has seen firsthand:  The shareholder suffered kidney failure in his early thirties. Due to the dialysis treatments he could no longer work.  Because his Social Security disability benefit was based on his low earned income, he was reduced to poverty for the rest of his life.

Social Security: Let’s now fast forward to the shareholder’s golden years.  If the wages paid were less than the Social Security maximum, the benefits are also less.  Most shareholders spend all of the tax savings realized during their working years.  Few people have the self discipline to deposit all the tax savings into their retirement accounts, potentially leaving the shareholder with too little to live on throughout their retirement.

Stress!

Besides the dollar and cents costs of these adjustments, the time and stress put on the shareholder(s) is not measurable, but very real. All of the time the shareholder(s) devotes to these issues distracts them from running their business.  This translates into lost profits.

There are numerous negative consequences to under or overstating compensation that can affect tax liabilities, disability insurance, retirement benefits and Social Security benefits. We need to strive to make sure our clients are paying themselves reasonable compensation.

We know identity theft is a frustrating process for victims. We are committed to working with you to resolve your case as quickly as possible.

What is tax-related identity theft?

Tax-related identity theft occurs when someone uses your stolen Social Security number to file a tax return claiming a fraudulent refund.

Generally, an identity thief will use your SSN to file a false return early in the year. You may be unaware you are a victim until you try to file your taxes and learn one already has been filed using your SSN.

Know the warning signs

Be alert to possible identity theft if you receive an IRS notice or letter that states that:

• More than one tax return was filed using your SSN;
• You owe additional tax, refund offset or have had collection actions taken against you for a year you did not file a tax return;
• IRS records indicate you received wages from an employer unknown to you.

Steps to take if you become a victim

• File a report with law enforcement.
• Report identity theft at ftc.gov/complaint and learn how to respond to it at identitytheft.gov.
• Contact one of the three major credit bureaus to place a ‘fraud alert’ on your credit records:
  • Equifax, www.Equifax.com, 1-800-525-6285
  • Experian, www.Experian.com, 1-888-397-3742
  • TransUnion, www.TransUnion.com, 1-800-680-7289
• Contact your financial institutions, and close any accounts opened without your permission or tampered with.
• Check your Social Security Administration earnings statement annually. You can create an account online at www.ssa.gov.

If your SSN is compromised and you know or suspect you are a victim of tax-related identity theft, take these additional steps:

• Respond immediately to any IRS notice; call the number provided
• Complete IRS Form 14039, Identity Theft Affidavit. Use a fillable form at IRS.gov, print, then mail or fax according to instructions.
• Continue to pay your taxes and file your tax return, even if you must do so by paper.

If you previously contacted the IRS and did not have a resolution, contact the Identity Protection Specialized Unit at 1-800-908-4490. We have teams available to assist.

How to reduce your risk

• Don’t routinely carry your Social Security card or any document with your SSN on it.
• Don’t give a business your SSN just because they ask – only when absolutely necessary.
• Protect your personal financial information at home and on your computer.
• Check your credit report annually.
• Check your Social Security Administration earnings statement annually.
• Protect your personal computers by using firewalls, anti-spam/virus software, update security patches and change passwords for Internet accounts.
• Don’t give personal information over the phone, through the mail or the Internet unless you have either initiated the contact or are sure you know who is asking.

The IRS does not initiate contact with taxpayers by email to request personal or financial information. This includes any type of electronic communication, such as text messages and social media channels.
Report suspicious online or emailed phishing scams to:phishing@irs.gov. For phishing scams by phone, fax or mail, call: 1-800-366-4484. Report IRS impersonation scams to the Treasury Inspector General for Tax Administration’s IRS Impersonation Scams Reporting.

Tax-related identity theft occurs when someone uses your stolen Social Security number to file a tax return claiming a fraudulent refund. You may be unaware you are a victim until you receive an IRS notice or you file your return, but it is rejected because your SSN already has been used. It’s important that you take steps to protect all of your personally identifiable information.

Don’t fall for common scams

• An unexpected email purporting to be from the IRS is always a scam. The IRS does not initiate contact with taxpayers by email or social media to request personal or financial information. If you receive a scam email claiming to be from the IRS, forward it to phishing@irs.gov.
• An unexpected phone call from someone claiming to be an IRS agent, either threatening you with arrest or deportation if you fail to pay immediately, is a scam. In another variation, the caller requests your financial information in order to send you a refund. Report these calls and other IRS impersonation schemes to the Treasury Inspector General for Tax Administration at 1-800-366-4484 or online at IRS Impersonation Scam Reporting.
• If you discover a website that claims to be the IRS but does not begin with ‘www.irs.gov,’ forward the link to phishing@irs.gov.

Tips to Protect your SSN and identifiable information

• Keep your card and any other document that shows your Social Security number in a safe place; DO NOT routinely carry your card or other documents that display your number.
•  Be careful about sharing your number, even when you are asked for it; ONLY share your SSN when absolutely necessary.
• Protect you personal financial information at home and on your computer.
• Check your credit report annually.
• Check your Social Security Administration earnings statement annually,
• Protect your personal computers by using firewalls, anti-spam/virus software, update security patches and change passwords for Internet accounts.
• Protect your personally identifiable information; keep it private. Only provide your SSN when YOU initiate the contact or you are sure who you know is asking.

About data breaches

Not all data breaches or computer hacks result in identity theft and not all identity theft is tax-related identity theft. It’s important to know what type of personally identifiable information was stolen. For example, did a data breach compromise your credit card or did it compromise your SSN?

If you’ve been a victim of a data breach, keep in touch with the company to learn what it is doing to protect you. Follow the steps recommended by the Federal Trade Commission’swww.identitytheft.gov site.

If your SSN was compromised, follow the steps outlined in the Taxpayer Guide to Identity Theft.

The IRS mails millions of notices and letters to taxpayers each year. There are a variety of reasons why we might send you a notice. Here are the top 10 tips to know in case you get one.

1.    Don’t panic. You often can take care of a notice simply by responding to it.

2.    An IRS notice typically will be about your federal tax return or tax account. It will be about a specific issue, such as changes to your account. It may ask you for more information. It could also explain that you owe tax and that you need to pay the amount that is due.

3.    Each notice has specific instructions, so read it carefully. It will tell you what you need to do.

4.    You may get a notice that states the IRS has made a change or correction to your tax return. If you do, review the information and compare it with your original return.

5.    If you agree with the notice, you usually don’t need to reply unless it gives you other instructions or you need to make a payment.

6.    If you do not agree with the notice, it’s important for you to respond. You should write a letter to explain why you disagree. Include any information and documents you want the IRS to consider. Mail your reply with the bottom tear-off portion of the notice. Send it to the address shown in the upper left-hand corner of the notice. Allow at least 30 days for a response.

7.    You won’t need to call the IRS or visit an IRS office for most notices. If you do have questions, call the phone number in the upper right-hand corner of the notice. Have a copy of your tax return and the notice with you when you call. This will help the IRS answer your questions.

8.    Always keep copies of any notices you receive with your other tax records.

9.    Be alert for tax scams. The IRS sends letters and notices by mail. The IRS does not contact people by email or social media to ask for personal or financial information.

10.    For more on this topic visit IRS.gov. Click on the link ‘Responding to a Notice’ at the bottom left of the home page. Also, see Publication 594, The IRS Collection Process. You can get it on IRS.gov/forms at any time.

The Affordable Care Act contains several tax provisions that affect employers. Under the ACA, the size and structure of a workforce – small, or large – helps determine which parts of the law apply to which employers.

The number of employees an employer had during the prior year determines whether it is an applicable large employer for the current year. This is important because two provisions of the Affordable Care Act apply only to applicable large employers. These are the employer shared responsibility provision and the employer information reporting provisions for offers of minimum essential coverage.

An employer’s size is determined by the number of its employees.

• An employer with 50 or more full-time employees or full-time equivalents is considered an applicable large employer – also known as an ALE – under the ACA.
• For purposes of the employer shared responsibility provision, the number of employees a business had during the prior year determines whether it is an ALE the current year. Employers make this calculation by averaging the number of employees they had throughout the year, which takes into account workforce fluctuations many employers experience.
• Employers with fewer than 50 full-time or full-time equivalent employees are not applicable large employers.
• Calculating the number of employees is especially important for employers that have close to 50 employees or whose work force fluctuates during the year.

To determine its workforce size for a year, an employer adds the total number of full-time employees for each month of the prior calendar year to the total number of full-time equivalent employees for each calendar month of the prior calendar year. The employer then divides that combined total by 12.

You may be tempted to forget all about your taxes once you’ve filed your tax return. Do not give in to that temptation. If you start your tax planning now, you may avoid a tax surprise when you file next year. Now is a good time to set up a system so you can keep your tax records safe and easy to find. Here are some IRS tips to give you a leg up on next year’s taxes:

• Take action when life changes occur.  Some life events can change the amount of tax you pay. Some examples that can do that include a change in marital status or the birth of a child. When they happen, you may need to change the amount of tax withheld from your pay. To do that, file a new Form W-4, Employee’s Withholding Allowance Certificate, with your employer. Use the IRS Withholding Calculatortool on IRS.gov to help you fill out the form.
• Report changes in circumstances to the Health Insurance Marketplace.  If you enroll in insurance coverage through the Health Insurance Marketplace in 2015, you should report changes in circumstances to the Marketplace when they happen. Report events such as changes in your income or family size. Doing so will help you avoid getting too much or too little financial assistance in advance.
• Keep records safe.  Put your 2014 tax return and supporting records in a safe place. If you ever need your tax return or records, it will be easy for you to get them. For example, you may need a copy of your tax return if you apply for a home loan or financial aid. You should use your tax return as a guide when you do your taxes next year.
• Stay organized.  Make tax time easier. Have your family put tax records in the same place during the year. That way you won’t have to search for misplaced records when you file next year.
• Shop for a tax preparer.  If you want to hire a tax preparer to help you with tax planning, start your search now. Choose your tax preparerwisely. Use the Directory of Tax Return Preparers tool on IRS.gov to find tax preparers in your area with the credentials and qualifications that you prefer.
• Think about itemizing.  If you claim a standard deduction on your tax return, you may be able to lower your taxes if you itemize deductionsinstead. A donation to charity could mean some tax savings. See the instructions for Schedule A, Itemized Deductions, for a list of deductions.
• Stay informed.  Subscribe to IRS Tax Tips to get emails about tax law changes, how to save money and much more. You can also get Tax Tips on IRS.gov or IRS2Go, the IRS mobile app. You’ll receive Tips each weekday in the tax filing season and three days a week in summer. You will also get Special Edition Tax Tips at other times during the year.

Planning now can pay off with savings at tax time next year

When you give a gift to charity that helps the lives of others in need. It may also help you at tax time. You may be able to claim the gift as a deduction that may lower your tax. Here are eight tax tips you should know about deducting your gifts to charity:

1. Qualified Charities.  You must donate to a qualified charity if you want to deduct the gift. You can’t deduct gifts to individuals, political organizations or candidates. To check the status of a charity, use the IRSSelect Check tool.

2. Itemized Deduction.  To deduct your contributions, you must file Form 1040 and itemize deductions. File Schedule A, Itemized Deductions, with your federal tax return.

3. Benefit in Return.  If you get something in return for your donation, your deduction is limited. You can only deduct the amount of your gift that is more than the value of what you got in return. Examples of benefits include merchandise, meals, tickets to an event or other goods and services.

4. Donated Property.  If you gave property instead of cash, the deduction is usually that item’s fair market value. Fair market value is generally the price you would get if you sold the property on the open market.

5. Clothing and Household Items.  Used clothing and household items must be in at least good condition to be deductible in most cases. Special rules apply to cars, boats and other types of property donations. SeePublication 526, Charitable Contributions, for more on these rules.

6. Form 8283.  You must file Form 8283, Noncash Charitable Contributions, if your deduction for all noncash gifts is more than $500 for the year.

7. Records to Keep.  You must keep records to prove the amount of the contributions you made during the year. The kind of records you must keep depends on the amount and type of your donation. For example, you must have a written record of any cash you donate, regardless of the amount, in order to claim a deduction. For more about what records to keep refer toPublication 526.

8. Donations of $250 or More.  To claim a deduction for donated cash or goods of $250 or more, you must have a written statement from the charity. It must show the amount of the donation and a description of any property given. It must also say whether the organization provided any goods or services in exchange for the gift.

Some people take an early withdrawal from their IRA or retirement plan. Doing so in many cases triggers an added tax on top of the income tax you may have to pay. Here are some key points you should know about taking an early distribution:

1.Early Withdrawals. An early withdrawal normally means taking the money out of your retirement plan before you reach age 59½.

2.Additional Tax. If you took an early withdrawal from a plan last year, you must report it to the IRS. You may have to pay income tax on the amount you took out. If it was an early withdrawal, you may have to pay an added 10 percent tax.

3.Nontaxable Withdrawals. The added 10 percent tax does not apply to nontaxable withdrawals. They include withdrawals of your cost to participate in the plan. Your cost includes contributions that you paid tax on before you put them into the plan.

A rollover is a type of nontaxable withdrawal. A rollover occurs when you take cash or other assets from one plan and contribute the amount to another plan. You normally have 60 days to complete a rollover to make it tax-free.

4.Check Exceptions. There are many exceptions to the additional 10 percent tax. Some of the rules for retirement plans are different from the rules for IRAs. See IRS.gov for details about these rules.

5.File Form 5329. If you made an early withdrawal last year, you may need to file a form with your federal tax return. See Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, for details.

6.Use IRS e-file. Early withdrawal rules can be complex. IRS e-file is easiest and most accurate way to file your tax return. The tax software that you use to e-file will pick the right tax forms, do the math and help you get the tax benefits you’re due. Don’t forget that with IRS Free File, you can e-file for free. Free File is only available through the IRS website at IRS.gov/freefile.

WASHINGTON — The Internal Revenue Service today warned return preparers and other tax professionals to be on guard against bogus emails making the rounds seeking updated personal or professional information that in reality are phishing schemes.
“I urge taxpayers to be wary of clicking on strange emails and websites,” said IRS Commissioner John Koskinen. “They may be scams to steal your personal information.”
Specifically, the bogus email asks tax professionals to update their IRS e-services portal information and Electronic Filing Identification Numbers (EFINs). The links that are provided in the bogus email to access IRS e-services appear to be a phishing scheme designed to capture your username and password. This email was not generated by the IRS e-services program. Disregard this email and do not click on the links provided.
Phishing made this year’s Dirty Dozen list of IRS tax scams. The full list is available on IRS.gov.
Phishing is a scam typically carried out with the help of unsolicited email or a fake website that poses as a legitimate site to lure in potential victims and prompt them to provide valuable personal and financial information. Armed with this information, a criminal can commit identity theft or financial theft.
If you receive an unsolicited email that appears to be from either the IRS or an organization closely linked to the IRS, such as the Electronic Federal Tax Payment System, report it by sending it to phishing@irs.gov.
In general, the IRS has added and strengthened protections in our processing systems this filing season to protect the nation’s taxpayers. For this tax season, we continue to make important progress in stopping identity theft and other fraudulent refunds.
It is important to keep in mind the IRS generally does not initiate contact with taxpayers by email to request personal or financial information. This includes any type of electronic communication, such as text messages and social media channels. The IRS has information online that can help you protect yourself from email scams.