QuickTaxnBooks Insights & Updates

The Internal Revenue Service warned employers to be wary of third parties who are advising them to claim the Employee Retention Credit (ERC) when they may not qualify. Some third parties are taking improper positions related to taxpayer eligibility for and computation of the credit.

These third parties often charge large upfront fees or a fee that is contingent on the amount of the refund and may not inform taxpayers that wage deductions claimed on the business' federal income tax return must be reduced by the amount of the credit.

If the business filed an income tax return deducting qualified wages before it filed an employment tax return claiming the credit, the business should file an amended income tax return to correct any overstated wage deduction.

ELECTION TO INCLUDE VALUE OF RESTRICTED STOCK OR PROPERTY IN GROSS INCOME IN YEAR OF TRANSFER UNDER CODE Section 83(B)

• A Section 83(b) Election is made to include the value of restricted property at the time of transfer (minus any amount you paid for the property) in your income for the year it is transferred.

• If you make this choice, the substantial vesting rules do not apply and, generally, any later appreciation in value is not included in your compensation when the property becomes substantially vested.

• Your basis for figuring gain or loss when you sell the property is the amount you paid for it plus the amount you included in income as compensation.

• To make the Section 83(b) Election, file a written statement with the IRS office where you file your return no later than 30 days after the date the property was transferred.

• You must sign the statement and indicate on it that you are making the choice under section 83(b) of the Internal Revenue Code

No exceptions to this rule are made.

S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly.

The instructions to the Form 1120-S, U.S. Income Tax Return for an S Corporation, state 'Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.'

The IRS has the authority to reclassify payments made to shareholders from non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes). Several court cases support the authority of the IRS to reclassify other forms of payments to a shareholder-employee as a wage expense which are subject to employment taxes.

The key to establishing reasonable compensation is determining what the shareholder-employee did for the S corporation by looking to the source of the S corporation's gross receipts.

The three major sources are: • Services of shareholder • Services of non-shareholder employees or • Capital and equipment

To the extent gross receipts are generated by services of non-shareholder employees and capital and equipment, payments to the shareholder would properly be treated as non-wage distributions that are not subject to employment taxes.

But to the extent gross receipts are generated by the shareholder's personal services, then payments to the shareholder-employee should be classified as wages that are subject to employment taxes.

Who is an Employee?

The definition of an employee for FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax Act) and federal income tax withholding under the Internal Revenue Code include corporate officers. When corporate officers perform a service for the corporation and receive or are entitled to payments, those payments are considered wages.

The fact that an officer is also a shareholder does not change this requirement. Such payments to the corporate officer are treated as wages. Courts have consistently held S corporation officers/shareholders who provide more than minor services to their corporation and receive, or are entitled to receive, compensation are subject to federal employment taxes.

If an officer does not perform any services or only performs minor services and is not entitled to compensation, the officer would not be considered an employee.

Distributions, Dividends and Other Compensation as Wages

Courts have found shareholder-employees are subject to employment taxes even when shareholders take distributions, dividends or other forms of compensation instead of wages.

One of the main reasons for small business owners to consider before creating LLC, Inc or a Trust is to understand that, in case of litigation, LLC / Inc / Trust cannot be ProSe.

Only a licensed attorney may represent an artificial entity such as a corporation, partnership, association, or trust in federal court.

Hays v. Hamblen Family Irrevocable Trust (In re Hamblen)