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Everything you need to help you launch your new business entity from business entity selection to multiple-entity business structures.
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Everything you need to help you launch your new business entity from business entity selection to multiple-entity business structures.
Designed for rental property owners where WCG CPAs & Advisors supports you as your real estate CPA.
Everything you need from tax return preparation for your small business to your rental to your corporation is here.
WCG’s primary objective is to help you to feel comfortable about engaging with us
Table Of Contents
By Jason Watson, CPA
Posted Thursday, November 2, 2023
In 1959, IRS Revenue Ruling 59-221 held that amounts of S corporation undistributed taxable income which are required to be included in each shareholder’s gross income do not constitute net earnings from self-employment to shareholders. However, in 1974, IRS Revenue Ruling 74-44 stated that “dividends” paid to shareholders will be recharacterized as wages when such “dividends” are paid to shareholders in lieu of reasonable compensation for services performed for the S Corp. The word “dividends” is in quotations because in reality we call these shareholder distributions, but in 1974 they referred to them as dividends.
This makes sense. Dividends being used to pay for services are truly wages. If Google or Amazon pays out a dividend to its shareholders, it is considered investment income. If your S corporation does the same thing to its only shareholder without an accompanying shareholder wage, then it is considered self-employment income and subject to the gaggle of taxes with that type of income.
Also, consider the words “in lieu of reasonable compensation.” This is to suggest that if shareholder salary is not processed and only shareholder distributions are paid, those distributions will be recharacterized as shareholder salaries. In other words, paying reasonable shareholder salaries protects shareholder distributions from being recharacterized as salary. But keep on an eye on that word “reasonable.” It is the kicker.
Moving on… There are several factors to consider when coming up with a reasonable salary to pay shareholders. The IRS through Fact Sheet 2008-25 released the following laundry list (last update was in 2008 when Flo Rida was singing Low… apple bottom jeans, boots with the fur, the whole club was looking at her. How time flies!)-
Clear as mud. This is the best the IRS can come up with? What is even more frustrating or perhaps embarrassing is that this list was the final draft after probably several meetings and rough drafts. Having said that, this is how our tax system operates in many ways- leave lots of wiggle room for interpretation so the law and the standards can evolve to meet the needs of today.
This list actually has two applications. Since C corporations have had a historically high tax rate including being double-taxed, many small C corporations want to drive corporate income close to zero by paying high salaries. The IRS and the Tax Court will use this list to say your salary is too high as a C Corp.
Conversely, S corporations want to increase corporate income (and available cash for shareholder distributions) by paying small salaries. The IRS and the Tax Court will talk out of the other side of their mouths by using this list to justify a higher salary. Yes, they get to have it both ways.
Here is a link to IRS Fact Sheet 2008-25-
This KB article is an excerpt from our 420+ page book (some picture pages, but no scatch and sniff) which is available in paperback from Amazon, as an eBook for Kindle and as a PDF from ClickBank. We used to publish with iTunes and Nook, but keeping up with two different formats was brutal. You can cruise through these KB articles online, click on the fancy buttons below or visit our webpage which provides more information.
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Please use the form below to tell us a little about yourself, and what you have going on with your small business or 1099 contractor gig. WCG CPAs & Advisors are small business CPAs, tax professionals and consultants, and we look forward to talking to you!
The tax advisors, business consultants and rental property experts at WCG CPAs & Advisors are not salespeople; we are not putting lipstick on a pig expecting you to love it. Our job remains being professionally detached, giving you information and letting you decide within our ethical guidelines and your risk profiles.
We see far too many crazy schemes and half-baked ideas from attorneys and wealth managers. In some cases, they are good ideas. In most cases, all the entities, layering and mixed ownership is only the illusion of precision. As Chris Rock says, just because you can drive your car with your feet doesn’t make it a good idea. In other words, let’s not automatically convert “you can” into “you must.”
Let’s chat so you can be smart about it.
We typically schedule a 20-minute complimentary quick chat with one of our Partners or our amazing Senior Tax Professionals to determine if we are a good fit for each other, and how an engagement with our team looks. Tax returns only? Business advisory? Tax strategy and planning? Rental property support?
Taxes can be tricky. Chat with a WCG human now and get questions answered.
Everything you need to help you launch your new business entity from business entity selection to multiple-entity business structures.
Designed for rental property owners where WCG CPAs & Advisors supports you as your real estate CPA.
Everything you need from tax return preparation for your small business to your rental to your corporation is here.
WCG’s primary objective is to help you to feel comfortable about engaging with us