There are audits risks with any business form, and for any taxpayer. Typically taxpayers under $200,000 in income face a 1% audit risk. And S-Corps face a 0.42% audit risk.
The Treasury Inspector General of Tax Administration (TIGTA) recently released figures about S-Corp audits. Over 62% of S-Corp audits resulted in a no-change audit. Good news. However, of those S-Corps with one shareholder and losses in excess of $25,000 for three consecutive years, the IRS had an average adjustment of $92,000 on the shareholder’s individual tax return. Wow! Truth be told, most S-Corp audit concerns stem from net profits being paid out as distributions without corresponding salaries, and the associated Social Security and Medicare taxes.
To reiterate, only 0.42% of S-Corps were audited, and of those examinations, a whopping 62% resulted in no change. That’s incredible odds. Same odds the Bears have of winning a Superbowl. Go Pack!
Back to audits- S-Corps have become super popular because of the low audit risk and more importantly the savings of self-employment taxes. The IRS is catching on however, and is targeting S-Corps where little to no salary is being paid to the shareholders. And this is easy to do. The IRS connects the dots by back-tracking K-1s to your company’s EIN to your company’s list of W-2s to the W-2’s Social Security numbers back to your K-1. The IRS probably has an app for that.
If your K-1 does not have a corresponding W-2, or if your W-2 income is low compared to your K-1 income you are creeping up on the “let’s call this guy” list. In other words, your audit risk is increasing.
As tax professionals we get concerned about S-Corps not paying themselves a reasonable wage for obvious reasons. And while it might appear that any salary will allow you to fly below the IRS radar, we strongly advise against it. The more abuse occurring in S-Corps is only going to attract the attention of Congress, and this quasi-loophole might close.