First, let us make it clear that we aren’t saying that your CPA or accountant is doing anything wrong. The accounting industry is one of the most honorable and respected fields around. That being said, there is a misconception that they are going to be proactive when advising clients about their taxes, and that’s just not part of the training most have received. Certainly some are, but the majority who know things about steps a business could take to perhaps be more aggressive, don’t feel it’s their responsibility to pursue a client in engaging in alternative accounting choices or behaviors.
A good example is “Bob” who owns a tire shop that has grown from two employees to three locations and 32 full and part time employees. The accountant did the payroll himself at first, but when they grew to 11 employees he set them up with ADP to handle the growing job. Now with 32 employees, the business would benefit greatly by joining a PEO (professional employment organization), saving as much as 50% on payroll costs and adding great HR and access to Health Insurance and DI and much more, but the CPA is busy and the company is still very profitable. “If it isn’t broken don’t fix it”, so the CPA says nothing about looking into a PEO.
The procedures for compensating yourself for your efforts in carrying on a trade or business are similar. The owner has been paying himself $85,000 a year because that’s what he needed to cover his lifestyle. He took it all as W-2 wages, even though the IRS offers information on averages of compensation and the business owner could have used a combination of wages, loans, dividends and even rent to receive the same amount of spendable dollars while paying much less federal tax.
The options available will depend on the type of business structure you elect. Below are topics that frequently arise when new business owners ask the Internal Revenue Service questions about how to pay themselves. A loan by a corporation to a corporate officer should include the characteristics of a loan made at arm’s length. That is, there should be a contract with a stated interest rate, a specified length of time for repayment, and a consequence for failure to repay the loan. Collateral would also be an indication of a loan. A below-market loan is a loan which provides for no interest or interest at a rate below the federal rate that applies. If a corporation issues you, as a shareholder or an employee, a below-market loan, the lender’s payment to the borrower is treated as a gift, dividend, contribution to capital, payment of wages, or other payment, depending on the substance of the transaction.
See “Below-market interest rate loans” under Employees’ Pay / Kinds of Pay / Loans or Advances in Publication 535, Business Expenses for more information. Because an officer of a corporation is generally an employee with wages subject to withholding, corporate officers may question what is considered reasonable compensation for the efforts they contribute to conducting their trade or business. Wages paid to you as an officer of a corporation should generally be commensurate with your duties. Refer to “Employee’s Pay, Tests for Deducting Pay” in Publication 535, Business Expenses for more information. Public libraries may have reference sources that provide averages of compensation paid for various types of services. The Internal Revenue Service may determine that adjustments must be made to the income and expenses of tax returns for both the corporation and an individual shareholder if the officer is substantially underpaid for services provided.
What’s our point? Come in and let us review your current business and personal tax returns and we’ll give you options to discuss and questions to ask your CPA or accountant, so that you can be sure you are taking full advantage of the opportunities available to you within the tax code.