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Wall Street Journal spotlights area CPA S corporation court loss

January 22, 2011

Today's Weekend Wall Street Journal picks up on the case of the local CPA who only paid himself a $24,000 salary on around $200,000 in income from his S corporation. He took the rest through his K-1, avoiding FICA tax on the K-1 amount. The U.S. District Court in Des Moines last month ruled that the CPA had to pay employment taxes on an additional $67,000 for two tax years.

The article says the CPA plans to appeal the decision. It quotes him as saying "The IRS can disallow a tax deduction for unreasonably high compensation, but the law doesn't give it the authority to raise pay in order to collect extra payroll taxes." The article adds:

Independent tax expert Robert Willens in New York says this will be a hard argument to win.

The article then goes on to discuss the problems of determining S corporation owner compensation:

What is a fair ratio of profits to pay? There isn't one answer, experts say. A company with substantial capital or assets, such as a manufacturer, often is able to justify lower pay than one selling personal services like a law or accounting firm. Says Mr. Willens: "I would tell a client that for personal services, 70% would be the absolute floor and might not get the job done," he says.

I don't think percentage estimates are that useful. There are many factors that come into play. The argument for paying high compensation would normally be stronger in a professional firm than in a manufacturing or distributive business, because more of the profit would be due to the owners' work. I don't think the IRS can force a struggling business to give its owner a raise to make the salary "reasonable." If you have an absentee owner, or minor children owning interests in a family business, zero can be a reasonable number.

In a professional practice, the place to start is probably the compensation of non-owner professionals. A full-time attorney or CPA owner who gets paid less than the hired help is asking for trouble.

UPDATE, 1/24: The TaxProf has more. The Iowa LLC blog also weighs in.

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