Reasonable Compensation

I know...you've heard this from me before. But it is such an important issue that I am going to keep reminding you.

The IRS repeatedly warns that S corp. owners must pay themselves “reasonable compensation”. Despite warnings, S corporation owners often neglect to put themselves on payroll…that is a regular payroll checks with tax payments for withholdings, filing W-2s, etc. Instead, many owners take out cash as a draw or distribution.

The IRS is on to this, is looking for it and you could be at-risk for an audit. The IRS will attempt to re-characterize all those draws as wages and subject them to all applicable payroll taxes. This re-characterization triggers back taxes, penalties and interest and have bankrupted other small businesses and owners.

So, you should pay yourself “reasonable compensation”. If you are unclear what that means, please call me. Together we can go through the steps needed to prevent an unwanted and painful IRS audit.

Bank loans to small business

Banks are often the accompanist to this common S corporation blunder: Banks often will loan money directly to your S corporation to buy equipment, building, etc. As odd as it sounds, have the bank loan you the money to you personally and then you loan the money to the S corp.  In order to take any losses of the S corporation, you must have at least that much basis (see e-mail sent last week) in your S corporation. But you only get basis from money you’ve personally invested in or personally loaned to the corporation. Bank loans made directly to the S corporation do not count. This S corporation tax mistake gets made all the time. S corporation owners have loans made to the S corporation but then can’t take any deductions because there is no basis! To add insult to injury, the S corporation loan may be personally guaranteed or dual titled (loan made to both S corporation and person) and still no deduction. If you have any questions about borrowing money from or lending money to your small business, please give me a call.

Basis and Distributions

I am often asked "What is basis"? Think of basis like a checking account. Investing in your business increase basis just like a bank deposit. A draw from your business decreases basis just like a bank withdrawal. Profits add to basis and losses decrease basis (similar to how interest earnings increase a bank balance and bank fees subtract from it). Just like a bank account, more basis cannot go out than comes in—basis can never go below zero.

So, if you are thinking about taking a distribution from your S-Corp. (or LLC taxed as an S-Corp.), please call me. We should calculate your basis first to make sure that a distribution will not create any unwanted tax problems. Remember…zero basis equals no tax free distribution!