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All Eyes Are on S Corporations

by Tracey Hrica, EA Jan 27, 2020 | Share

One of the fallouts from the Tax Cuts and Jobs Act (TCJA) is the increased scrutiny by the IRS of S corporations and their shareholders. They are especially interested in several tax liability issues regarding distributions, officer loan repayments, officer salaries, and the sale of assets acquired while a C corporation.

Reasonable Salary

A shareholder of an S Corporation is required to take reasonable wages from their profitable business.  By not doing so, they increase their chances of audit, as well as lose the full deduction of any shareholder health insurance premiums.  To take the full deduction, these premiums must be reported on a W2.  If not, they are reported on the shareholder’s personal tax return, but subject to limitations.  If audited, the IRS can conclude that an S corporation shareholder has attempted to evade payroll taxes by disguising employee salary as corporate distributions. They can recharacterize the distributions as salary and require payment of employment taxes and penalties which can include payroll tax penalties of up to 100% plus negligence penalties.

Distributions

When the S corporation makes distributions, they are not considered income as long as the distribution does not exceed the shareholder’s stock basis. Any excess is taxed as a capital gain on the shareholder’s personal tax return.

Stock basis is the measure of investment made by each shareholder. You begin calculating stock basis with the amount of money and property the person contributed to the business when the shareholder joined the S Corporation. Every year you increase the basis by the amount of the corporate income that you report on your taxes. This includes ordinary income, tax-exempt income (which you still must report), and excess depletion incurred on the business’s assets. The shareholder’s basis in the business is decreased by the stockholder’s share of the business’s losses and the S corporation’s nondeductible expenses. Any additional funds the stockholder transfers from the business will increase the stockholder’s basis; any distribution the stockholder receives from the S corporation will decrease his basis

Loan Repayments

Loans made to shareholders can be a particularly problematic issue with the IRS.  If audited, unless the loan is documented, and has repayment with interest, the loan will be reclassified as a distribution.  Without the stock basis mentioned above, there will be capital gains.

New Checkbox on Schedule E

S corporation shareholders should be aware of a new checkbox added to line 28 of the individual taxpayer return, Schedule E (Form 1040). This box should be checked if the shareholder is reporting a loss, has received a distribution, has disposed of stock or has received a loan repayment from an S corporation. The shareholder must attach documentation that details their S corporation ownership basis.

Conclusion

As the IRS is cracking down in these areas, it is imperative that S corporation shareholders stay on top of these issues.

About the Author

Tracey Hrica, EA

Tracey Hrica joined the firm in 1995. She is an Enrolled Agent(EA), which enables her to prepare personal and business tax returns and represent clients before the IRS. Working closely with her clients, Tracey’s primary areas of concentration are new client set up and QuickBooks support. As a QuickBooks ProAdvisor, she works closely with clients who rely on QuickBooks for the day to day running of their business. Tracey has expertise in both QuickBooks Desktop and QuickBooks Online.

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