2-1 Discussion

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Jan 9, 2024

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Hi Professor and classmates, "An S corporation or S corp, also known as an S subchapter, refers to a type of corporation that meets specific Internal Revenue Code requirements. The S corp is a structure that offers certain tax advantages over C corporations, or C corps, which make up most corporations. For example, an S corp – but not a C corp – may pass income (along with other credits, deductions, and losses) directly to shareholders, without having to pay federal corporate taxes" (Kagan, 2022). "To obtain S corporation status, a corporation must make a special election, and its shareholders must consent to that election (Pope et al., 2021). Every company should pay payroll taxes when a salary is paid out to their employees because if they don't, it is considered fraud. To avoid paying payroll taxes, employers will pay distributions to an employee instead of compensating them for their time at work. The employee and the employer split the payroll taxes, known as FICA Taxes, which consist of Social Security Tax and Medicare Tax. In 2022, the social security maximum earnings increased from $142,800 to $147,000 (Hanks, 2021). "The Social Security tax rate for employees and employers remains unchanged at 6.2%. The combined Social Security and Medicare tax rate for employees and employers remains unchanged at 7.65%. Medicare tax will also apply to all wages in excess of $147,000 and will be imposed at a rate of 1.45% for both employees and employers. The earnings base for self-employment tax will also increase to $147,000, with an effective rate of 15.3%. Medicare tax will continue to apply on all self-employment income in excess of $147,000 at an effective rate of 2.9%. No self-employment tax is payable if annual net earnings are less than $400. All wages currently subject to Medicare tax are subject to an additional 0.9% Medicare tax withholding when wages exceed $200,000" (Boyer, 2022). There is a strategy that the Internal Revenue Service should use to help mitigate these issues. Suppose an owner of the S Corporation is caught trying to avoid payroll taxes. In that case, the IRS "can recharacterize the distributions as salary and require payment of employment taxes and penalties which can include payroll tax penalties of up to 100% plus negligence penalties" (Fishman, 2014). The IRS should continue to perform audits on these S-Corporations. If the IRS finds out that an employee was paid low compensation for his work and was paid a lot of money in dividends, the IRS can switch the dividends to wages. Therefore, the wages can now be subjected to an employment tax according to the court case of (Watson v. United States, (DC IA 05/27/2010) 105 AFTR 2d. (Fishman, 2014). Another

strategy would be to increase fines and possible jail time for the owner of the S- Corporation. There is a fine line on payroll taxes when it comes to the employee because the employee can also be the employer/owner, just like in this case, "Glass Blocks Unlimited VS Commissioner of Internal Revenue". Moreover, in this case, the employee was paid high distributions for his work and meager compensation for his work. Glass Blocks Unlimited figured by paying the employee high distributions, they would not be subject to employment and payroll taxes. Regards, References Boyer, C. (2022, January 6). 2022 payroll tax and withholdings update . Anders CPA. Retrieved January 12, 2023, from https://anderscpa.com/2022-payroll- tax-and-withholdings/ Fishman, S. (2014, October 31). S corporations and salaries: An IRS hot button issue . www.nolo.com. Retrieved January 12, 2023, from https://www.nolo.com/legal-encyclopedia/s-corporations-salaries-an-irs-hot- button-issue.html Glass Blocks Unlimited v. COMMISSIONER OF INTERNAL REVENUE , 2013 T.C. Memo 180 (T.C. 2013). Hanks, M. (2021, December 3). Payroll updates and important information for 2022 . Isler CPA. Retrieved January 12, 2023, from https://islercpa.com/payroll-updates-and-important-information-for-2022/ Kagan, J. (2022, September 28). What is an S corp? Investopedia. Retrieved January 12, 2023, from https://www.investopedia.com/terms/s/subchapters.asp Pope, T.R., Rupert, T.J., & Anderson, K.E. (2021). Pearson’s Federal Taxation 2021 Comprehensive . New York, NY: Pearson.

Hi Jacob, I enjoyed reading your discussion post this week. In both of our discussions, we both mention an S corporation that “may pass income (along with other credits, deductions, and losses) directly to shareholders, without having to pay federal corporate taxes” (Kagan, 2022). You also mentioned noticeable “red flags” that the I.R.S. can locate and investigate. I also think the I.R.S. is becoming aware of the new digital platforms and how gaining access to the information and data on these sites can assist with determining potential tax evasion more effortlessly. To expand on Professor Kirkland’s response, many people use digital platforms for buying and selling. With the I.R.S. having access to even more data for business transactions, some users of digital wallets and e-commerce platforms such as Venmo, Cash App, and Etsy must start reporting small transactions. In an effort to get ahead of the problem, the I.R.S. pushes a tax change intended to dissuade tax evasion by small businesses means more paperwork from the I.R.S. Unfortunately, many taxpayers who run small businesses or occasionally sell goods on the side often mix their business and personal transactions. As a result, they could face messy disputes with the I.R.S. if their tax forms inaccurately show them making more income than they actually earned. Regards, Melissa Nguyen References Rappeport, A. (2022, December 21). How new I.R.S. rules could affect Venmo, Etsy and Cash App users . The New York Times. Retrieved January 15, 2023, from https://www .nytimes.com/2022/12/21/business/irs-online-sales-tax- bills.html

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Hi Ginnel, I agree with your statement of "a huge gray area" related to what is "reasonable" compensation. A reasonable wage will differ significantly among society due to many factors. Therefore, laws should be more black-and-white to avoid discrepancies between the taxpayer and the I.R.S. Also, the I.R.S. provides guidelines and tips for determining how much compensation is "reasonable." However, it is definitely still a gray area. It is like treading the needle between paying an amount that is too high or too low, depending on the situation. Reasonableness is very fact sensitive, and what is reasonable in one context may be unreasonable in another. Forbes editor Daniel Mayo (2022) states, "Recognizing that the determination of reasonableness is more art than science, some practitioners suggest a 60-40 approach as a rule of thumb." Additionally, your mitigation method is a successful way for business owners to avoid any issues with the I.R.S. If adequate research is conducted when determining a reasonable pay for an employee, the I.R.S. will likely not audit the company. Thank you for providing such a detailed post on this week's topic; I enjoyed reading your thoughts. Regards, Melissa Nguyen References Mayo, D. (2022, April 18). Is your compensation reasonable? for tax purposes, that is . Forbes. Retrieved January 15, 2023, from https://www.forbes.com/sites/danielmayo/2022/04/15/is-your-compensation- reasonable/?sh=a5105fc71816

2-1 Discussion

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