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    S Corporation Distributions Reclassified as Salary

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    The IRS audited S. Johnson's tax returns for the 2010 through 2012 and classified the $260,000 of distributions as salary income for each year.

    What IRC is used to support the claim of the distribution as income based on the following facts and for the tax research memo?

    S. Johnson and K. Morrison, attorneys at law, formed a partnership, Johnson and Morrison, Attorneys at Law, in 2002. In 2010, S. Johnson formed Johnson, P.C., and a professional corporation and entered into an employment contract to provide all his legal services to Johnson, P.C. From 2010 to 2012, S. Johnson provided legal services exclusively to Johnson and Morrison, Attorneys at Law, and its clients as an employee of Johnson, P.C. Johnson, and P.C. made distributions of $275,000 for each year, 2010, 2011 and 2012 to S. Johnson. Johnson, P.C. has operated as an S Corporation since 2010 when it was formed. S. Johnson is the sole shareholder of Johnson, P.C. and authorized a salary of $25,000 per year to be paid to him during the three years at issue. S. Johnson reported $25,000 of salary income and $235,000 of dividend distributions for each of the three years.

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    Solution Preview

    In this scenario, we have Johnson and Morrison, who formed a partnership. Johnson then formed a corporation as the sole shareholder. He formed a contract by himself to the corporation as the sole shareholder (there is a question of legality here, but that's a different issue). As per the sole contract to the corporation, he could only offer legal services to the corporation. This also may be a violation of the partnership agreement. Johnson then performed legal services solely to the partnership and clients of the partnership.

    The S Corporation, of which Johnson is the sole shareholder, made distributions of 275,000, and he had a salary of 25,000. He then reported 235,000 in distributions and 25,000 of income.

    There are a few areas that you need to address in this case.

    It is important for you to know that S Corporation officer salary is a big, big topic. A few years back, the IRS began to discover that S Corporation shareholders were doing just as ...

    Solution Summary

    This solution discusses the S. Johnson and K. Morrison partnership tax case in great detail. The reclassification is thoroughly explained, with a final determination regarding the legality of any reclassification attempt by the IRS. References and resources are also provided.