Monday, November 21, 2022



  • 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.


Sunday, November 20, 2022

S corporation Reasonable Compensation

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.

In addition to gross receipts generated directly by the shareholder-employee, the shareholder-employee should also be subject to wage treatment for administrative work performed by him for the other income-producing employees or assets. For example, a manager may not directly produce gross receipts, but he assists the other employees or assets which are producing the day-to-day gross receipts.

Some factors in determining reasonable compensation:

  • Training and experience
  • Duties and responsibilities
  • Time and effort devoted to the business
  • Dividend history
  • Payments to non-shareholder employees
  • Timing and manner of paying bonuses to key people
  • What comparable businesses pay for similar services
  • Compensation agreements
  • The use of a formula to determine compensation


S Corporation Employees, Shareholders and Corporate Officers

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.

In 2001, in a Tax Court case against a Veterinary Clinic, the Tax Court ruled that an employer cannot avoid federal taxes by characterizing compensation paid to its sole director and shareholder as distributions of the corporation’s net income rather than wages.  Veterinary Surgical Consultants, P.C. vs. Commissioner, 117 T.C. 141 (2001).

The Sixth Circuit held that a shareholder-employee of a company used the company bank account for personal use.  As such, the Court ruled the shareholder was an employee and owed employment tax. Joly v. Commissioner, T.C. Memo. 1998-361, aff’d by unpub. op., 211 F.3d 1269 (6th Cir. 2000).

In yet another similar case, the Tax Court held that an accountant was taking dividends and performing duties for the company. The Tax Court ruled the dividends were actually wages, subject to employment taxes. Joseph M. Grey Public Accountant, P.C. vs. Commissioner, 119 T.C. 121 (2002).

In the above listed cases the shareholders failed to report any wages from their S corporations. In a 2012 case the shareholder received wages of $24,000 per year and large distributions. Though there was no dispute that the shareholder was an employee, the issue dealt with the reasonableness of the wage amount. When challenged on the reasonableness of the wages, the taxpayer contended that the corporation only intended to pay wages of $24,000 and that its intent was controlling. The 8th Circuit disagreed and sustained the District Court which held that the test is whether the payments received by the shareholder were truly remuneration for services performed, thus the intent to limit wages is not a controlling factor. David E. Watson, PC vs. U.S., 668 F.3d 1008 (8th Cir. 2012). The Supreme Court held that it would not hear an appeal of the 8th Circuit decision. 

Other decisions:

Payments made by an S corporation to its president and sole shareholder were wages subject to employment taxes, not distributions or loan repayments.  Prior transfers by the shareholder to the corporation were capital contributions and not loans.  The court rejected the argument that the distributions would represent unreasonable compensation to its president. Glass Blocks Unlimited v. Comm’r, T.C. Memo. 2013-180.

The corporation’s payment of the shareholder’s personal expenses for insurance and utilities were made with the intent to compensate the shareholder for services rendered.  As such, the corporation was entitled to a deduction as additional compensation.  The amounts when combined with small amounts of “management expenses” paid by the corporation were not unreasonable.  Ghosn v. Comm’r, T.C. Memo. 1995-192.

Purported “loans” from S corporation to its sole shareholder, officer, and director, were wages for purposes of FICA and FUTA taxes.  The loans were unsecured demand notes bearing no interest, loans were made entirely at the discretion of shareholder, and the shareholder regularly performed substantial, valuable services for taxpayer.  Repayment of loan was “simply a paper transaction” in which outstanding loan balance was credited against undistributed income and rental payments owed by the corporation to the shareholder. Gale W. Greenlee, Inc. v. U.S., 661 F. Supp. 642 (D. Colo. 1985).

If the shareholder received or had the right to receive cash or property, then the S corporation must determine and report an appropriate and reasonable salary for that shareholder. 

Next Blog : S Corporation Compensation and Medical Insurance Issues for more details on what is considered to be reasonable compensation.


Friday, November 18, 2022

Caution before forming Trust or LLC or Inc

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)