Watch Out for This S Corp Audit Red Flag | USTaxAid Watch Out for This S Corp Audit Red Flag | USTaxAid

Diane Kennedy's Blog

Watch Out for This S Corp Audit Red Flag

Written by Diane Kennedy, CPA on January 20, 2023

The IRS is currently auditing six S Corporations per 1000. That means that an S Corporation has a very low chance of audit.

That is one of the things the IRS is supposed to do with their new found budget increase, audit more businesses. And S Corporations are obviously a good place to start when you consider how few audits there are for S Corporations.

One of the first targets will likely be “reasonable compensation” for employee/shareholders.

If you work for your S Corporation you are supposed to pay yourself a reasonable salary. If the IRS determines that you are taking distributions instead of a fair amount of salary in order to lower payroll taxes, they may recharacterize the payments as salary. That will mean employment taxes, penalties, and interest.

The term “reasonable” is more subjective, though. It’s a payment you would make to someone else who did the work you do for the company with the type of hours that you work. However, if your business is running at a loss or has a slight amount of income, the IRS does understand that your salary will be lower.

This is one reason why it pays to have an experienced tax professional helping you file your return.

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