Shareholder’s Compensation and Her Corporation’s Deduction

So you say your “S” corporation is looking high and low for ways to offset some or all of its profits earned during the stellar 2011 tax year.  And the thought occurs to you that because it uses the accrual method of accounting (recognizing expenses when incurred, which may precede the date of actual payment), you can snooker Uncle Sam:  accrue and deduct in 2011, even though the actual payment to you doesn’t occur until 2012.  Aha!  You get the deduction now, and don’t have to pay tax at the personal level on the income until next year!

But “not so fast,” says the Internal Revenue Code.  An accrual-basis “S” corporation cannot deduct expenses, including salaries and bonuses, paid to a shareholder or someone related to a shareholder until the payment is includible in the payee’s income.  Code Section 267 effectively overrules the fundamental accrual concept in this case – placing both the corporation and shareholder salary recipient on the cash method of accounting.

And it doesn’t matter that our shareholder only owns a small percentage of the stock – every shareholder is entitled to this tax treatment!  Also, the rule doesn’t just apply to salaries or bonuses, but also pertains to other types of expenses, such as rents and interest.

A slightly looser rule for “C” corporations and their shareholders:  the same concept of matching the deduction and the income applies, alright, but only in the case of a corporation and a more than 50% shareholder.  Minority shareholders can skate.

And from our “you don’t say” department come words of wisdom recently uttered by IRS Commish Douglas Shulman in a speech at Harvard’s Kennedy School of Government.  “Making the tax code less complex is the single most important thing that could be done to improve taxpayer service and boost compliance.  Complexity can lead people to not take advantage of tax benefits, largely credits and deductions, that Congress intended them to have, either because they don’t understand them or are afraid they may be ineligible.”

Shulman went on to note that at present, something like 90% of individual taxpayers spend dough, each year, for professional tax preparation or tax software.

Complexity aside, however, leave it to the IRS’ Advisory Council (public forum comprised of IRS functionaries and some public folk, including tax professionals) in its 2011 Public Report, to observe that “IRS must receive adequate funding commensurate with its

ever-increasing responsibilities and workload to remain effective.”

Really.  Nothing like an increase in the budget to enable the agency to improve its “taxpayer service.”  And while dreaming up new “services” on which to spend your money, the bureaucrats have even come with some new bafflegab, in noting that, “The IRS has become expert in the art of “flexecution” (flexibility in the execution of their planned operations) while regularly called upon to redeploy precious resources to emerging areas of tax noncompliance throughout the world.”

Now that you know that, don’t you feel so much better about your favorite government agency?

CONSULT YOUR TAX ADVISOR – This article contains general information about various tax matters.  You should consult your CPA regarding the implications to your own particular situation.

Jeff Quinn, the author of this article, is a shareholder in Ashley Quinn, CPAs and Consultants, Ltd., with offices in Incline Village and Reno.  He can be reached at 831-7288, welcomes comments at jquinn@ashleyquinncpas.com, and invites readers to consider his other commentary at http://blog.nolo.com/taxes.

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