The IRS has been on a roll ever since it racked up a big win in Watson v. U.S.—in which an appellate court ruled that the IRS can recharacterize FICA-free distributions from S corps to their owners as FICA-taxable compensation, and allowed the IRS to set the parameters for determining that reasonable FICA-taxable salary. And so far it’s nailed S corps and their owners 100% of the time. Two recent cases illustrate.
Loss No. 1: Distributions and loans were salary. The president and sole shareholder-employee of an S corp worked full time for his company. The S corp’s 2007 and 2008 Forms 1120S reported that it paid him no salary, but made FICA-free distributions to him of $30,844 and $31,644, respectively. The 2007 and 2008 Forms 1120S reported $29,132 and $8,391, respectively, in loan repayments to him. The S corp also paid him $21,078 in dividends for 2008.
After a payroll audit, the IRS concluded that the distributions and lo...(register to read more)