We hope you are having a wonderful summer! It’s hard to believe that we’re almost in August already.
A new report by the Treasury Inspector General for Tax Administration notes that IRS audits have led to a substantial number of recommended adjustments reported on S corporation returns; however, the number of no-change audits was 62% in fiscal year 2011 for returns selected by the “Discriminant Index Function system”.
The IRS plans to analyze data files to better identify productive S corporation returns for audit. The growth in the number of S corporation returns processed has continued since 1997 when they became the most common type of corporation return filed.
The IRS estimates there will be a 26% increase in S corporation returns from the 2011 processing year to the 2015 processing year. What’s the take-away from this information? There will be a lot more S Corporation audits and IRS wants to focus on “Productive” S Corporation returns.
If you are a stockholder in a “Productive” Subchapter S Corporation, there are some things that, at a minimum, you should ensure are being handled properly. First of all, make sure that stockholder/employees are being compensated adequately. We can’t emphasize enough how big an issue this is and we have suspected that IRS would intensify its focus here.
Secondly, make sure that Mileage Logs are prepared and maintained for company owned or leased vehicles utilized by stockholder/employees (or family members or, frankly, any one else that drives a company vehicle). Personal use of company vehicles is always covered in any business tax return audit. If your S Corporation is not maintaining mileage logs, you will lose tax deductions.
Finally, verify that all transactions between stockholders and the S Corporation are supported by appropriate documentation. If transactions aren’t properly documented, IRS would reclassify them as disguised compensation subject to payroll taxes (including the new ObamaCare medicare tax that takes affect in 2013). Reclassification of these amounts as additional compensation would also result in IRS claiming that previously filed payroll tax returns were incorrect and subject to additional tax, penalties, fines and interest.
Transactions requiring appropriate documentation would include, for example:
Lease agreements for S corporation rental of stockholder owned property(ies),
- Board minutesprepared for all board meetings (with at least an annual board meeting, at a minimum),
- Stockholder distributionsare made in direct proportion to stock ownership and as a part of a plan of distribution (rather than indiscriminately),
- Stockholder/Employees should submit expense reportsfor reimbursement of out-of-pocket expenses, just like every other employee.
This is serious news and it will require a large number of Subchapter S corporations to take a good hard look at how they are doing things. We have learned that, in many cases, IRS agents like “form” over “substance” so it’s imperative that you have all of your S Corporation documentation handled properly.
Time is on our side. Take some time to review your business practices and make sure that you’ve got your Subchapter S Corporation “I’s” dotted and “T’s” crossed. We can help – please let us know if you need some guidance.