1. Chapter 7- Related Parties – Compensation and Loans to Officers
121
Chapter 7- Related Parties – Compensation and Loans to Officers
Reasonable comp
Loans vs Capital contributions to S Corps

2. An individual lends a $1,000,000 to his S Corp
An individual lends a $1,000,000 to his S Corp. He then takes no salary but has the Corp pay his personal expenses?
This is a disaster.
I hope he set it up as a contribution of capital rather than a loan.
He better have set this up as a loan.
This guy got lucky.
Better to set it up as a loan but this guy did get lucky. Scott Singer Installations – Item H. page 129.

3. The S Corp Compensation
121
The S Corp Compensation
Several cases where the taxpayers were advancing funds to S Corps, taking repayments and not taking salary.
The question is it better to lend the money or treat it as a capital contribution.
PATAP

4. The S Corp Compensation
122
The S Corp Compensation
Glass Blocks Unlimited, TC Memo
Finding distributions from the corp. were wages to the president/ shareholder.
During a down turn owner the only full-time employee ended up transferring funds to his corporation.
This issue was is this a loan or a capital contribution.
Factors court looked at are on page 122.
PATAP

5. The S Corp Compensation
122
The S Corp Compensation
Glass Blocks Unlimited, TC Memo
Finding distributions from the corp. were wages to the president/ shareholder.
No wages were paid but loan repayments were made at the shareholder’s request.
Court ruled that the transfers were capital contributions not loans.
Distributions were dependent on the success of the business rather than on an unconditional payment?
Taxpayer provided 100% of the personal services to the business.
PATAP

6. The S Corp Compensation
129
The S Corp Compensation
Compare to the Singer Installation Case on page 129.
From singer advanced $1,160,343
Advances recorded on the books as loans
For audit years , the S Corp paid personal expenses of $181,872.- these were recorded as repayments of loans on its books and tax returns.
No payments were treated as wages or salary subject to employment taxes.
PATAP

7. The S Corp Compensation
129
The S Corp Compensation
Singer Installations Case page 129
IRS wanted to reclassify all payments as “compensation”.
PATAP

8. The S Corp Compensation
129
The S Corp Compensation
Singer Installations Case page 129
Court findings:
advances of $646,443.- reasonable to categorize as loans when the company was profitable.
advances considered as capital contributions. Years that the business was struggling.
Court indicated that the taxpayer had sufficient outstanding balances and repayments were correctly identified as loans.
PATAP

9. The S Corp Compensation
129
The S Corp Compensation
Singer Installations Case page 129
IRS disagreed with findings in Action on Decision -AOD
Court failed to determine if payments to Mr. Singer’s creditors were for services.
The court focused in on the debtor creditor relationship and did not analyze or cite relevant statutory or regulatory provisions governing wages.
PATAP

10. The S Corp Compensation
129
The S Corp Compensation
IRS disagreed with findings in Action on Decision -AOD
While the Service may recognize a payment from a corporation to its shareholder-officer who is also an employee as a loan repayment, the taxpayer must provide objective evidence that both substantiates that a bona fide loan exists between the parties and substantiates that the payment from the taxpayer to the employee was specifically in repayment of that loan and is separate from compensation paid to the employee for the performance of services f or the taxpayer.
PATAP

11. The S Corp Loans Vs Capital- My take
129
The S Corp Loans Vs Capital- My take
Loans especially well documented loans with scheduled repayments better than contributions for this issue.
Loans repayments are not discretionary
Should be properly documented
Chances of being sustained as a loan are better if the company has a repayment capability.
Chances of being sustained if there are others providing services in the business.
PATAP

12. The S Corp Loans Vs Capital- My take
129
The S Corp Loans Vs Capital- My take
Be careful with structuring transfers of money to losing C Corps.
Defaulted loans will be treated as either:
Personal bad debt, or
Employee business bad debt- Misc. 2% itemized
Consider issuing stock – 1244 loss treatment page 42. of the manual.
PATAP

13. Reasonable Compensation
121
Reasonable Compensation
What would an independent investor approve?
Reasonable salary
Industry comparison
Bus. Size/ complexity
Prior compensation
BOD actions
Div. Payments
Agreement

14. Reasonable Compensation
121
Reasonable Compensation
Services performed
Receive loans or distributions
Is anyone else working ?
% of Ownership
What would they make elsewhere
Is there a formula?
Compensated as less than prevailing rates.
Comp. significantly different than those performing similar duties.

15. Income Approach- business valuation
125
IRS Methodology
Three Approaches
Market Approach- try to match the comp to other similar sized companies
Income Approach- business valuation
Cost Approach- break down the duties and apply a cost to them.
Market Approach –Compare the compensation to the industry
How much compensation would be paid to a non-owner in the same position??
PATAP

16. IRS Methodology- Market Approach
Compare the taxpayer to comparable companies
Median is the amount that is in the middle
If you have an odd number of items it is the middle number
If you have an even number of items it is the mean of the two values
PATAP

17. Difficult to apply to small business because you need public data.
Market Approach
Difficult to apply to small business because you need public data.
PATAP

18. IRS Methodology- Income Approach
Time consuming
Need comparable business
Compare the taxpayer to comparable companies
Median is the amount that is in the middle
If you have an odd number of items it is the middle number
If you have an even number of items it is the mean of the two values
PATAP

19. IRS Methodology- Cost Approach
125
IRS Methodology- Cost Approach
Interview the taxpayer
Break down the duties
Apply a rate to the duties based on comparable salaries.
Most often used by small businesses
Compare the taxpayer to comparable companies
Median is the amount that is in the middle
If you have an odd number of items it is the middle number
If you have an even number of items it is the mean of the two values
PATAP

20. Reasonable Wage Summary
Better to figure this at the beginning of the year than at the beginning of the audit.
Better with a reasonably high or low salary than no salary.
Use resources including Bureau of Labor Statistics.
PATAP

21. Reasonable Wage Summary
133
Reasonable Wage Summary
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GearUp100- $100 off of the $540
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PATAP

22. Reasonable Wage Summary
My contact at Rcreports
Paul S. Hamann
Phone
PATAP

23. Question
A service S Corporation earns $2,975,928 prior to employee/owner salaries. The client asks you what is a reasonable salary. You Say:
A) None- its too much work to file payroll tax returns and pay taxes.
B) $125,162
C) $450,255
D)$2,000,000

24. Newt Gingrich
Paid salary of $450,255.
S income of
$2,525,683.
Medicare Savings
-$73,244
-$98,501 in 2016

25. How about a $360,000 salary and
$10,559,000 in S Earnings
Medicare Savings
$306,211
$401,242 in 2016

26. Watson Case- Supreme Court Declined to Review
128
Watson Case- Supreme Court Declined to Review
Larson, Watson, Bartling & Eastman Partnership
WATSON PC
Owner
Watson owned 25% of Larson, Watson, Bartling & Eastman which he contributed to an S corporation.
Watson argued originally IRS didn’t have the power to change a negotiated agreement between him and the company
PATAP

27. Watson Case- Supreme Court Declined to Review
128
Watson Case- Supreme Court Declined to Review
Watson used a S Corp to be the owner of his interest in a CPA partnership.
S Corp billed the partnership for services
The S Corp paid:
2002
2003
CPA Firm Rev
2,349,556
2,949,739
Salary
$24,000
Distributions
203,651
$175,470
Watson owned 25% of Larson, Watson, Bartling & Eastman which he contributed to an S corporation.
Watson argued originally IRS didn’t have the power to change a negotiated agreement between him and the company
PATAP

28. Watson Case- Supreme Court Declined to Review
128
Watson Case- Supreme Court Declined to Review
IRS Expert
AICPA Management Accounting Practice (MAP) Survey for Iowa.
A owner-employee average $70,000 annually
Watson’s billing rate was 33% higher than average.
Reasonable Salary would be $93,000
Watson owned 25% of Larson, Watson, Bartling & Eastman which he contributed to an S corporation.
Watson argued originally IRS didn’t have the power to change a negotiated agreement between him and the company
PATAP

32. Bona Fide Debt 135 Presence of note Schedule of repayment
Reasonable % is required
Collateral obtained
Demand for repayment
Payments have been made
Transaction reflected as debt by both parties
Financial condition of debtor- see Shaw Case
Shareholder lacks complete control
Restrictions by board
Corp. pays dividends
Intends to pay and can pay without liquidation
Collection enforced or documents amended
Meaningful amounts are repaid

33. 141
Below Market Loans
C Corp Lends to Shareholder. Interest is Imputed. C Corps. Books Shareholder DR CR
Interest Expense
1,000
Dividend Income DR CR
Dividend
1,000
Interest Income
Corporation has additional income of $1,000.
Shareholder has dividend income but may or may not have an interest deduction.

34. 141
Below Market Loans
S Corp Lends to Shareholder. Interest is Imputed. S Corps. Books Shareholder DR CR
Dist,or Comp
1,000
Interest Income DR CR
Int. Expense
1,000
Dividend or wage
Shareholder may or may not have dividend income and may or may not have interest expense deduction.
Corporation has additional income of $1,000.

35. 141
Below Market Loans
Shareholder Lends to Corp. Interest is Imputed. C Corps. Books Shareholder DR CR
Interest Expense
1,000
Paid In Capital DR CR
Investment in Co.
1,000
Interest Income
Corporation has an additional expense of $1,000.
Shareholder has interest income.