Karl Stick is president of Stock Company. He also owns 100 percent of its stock. Karl's salary is $120,000. At the end of the year, Karl was paid a bonus of $100,000 because the firm had a good year. Stock Company deducted $220,000 as compensation expense for the year. Upon audit, $80,000 of the deduction was disallowed. How could this happen? How would you advise Stock Company?© BrainMass Inc. brainmass.com June 25, 2018, 8:14 am ad1c9bdddf
The conclusion of the IRS auditor is not uncommon in this situation.
Here's the problem:
Karl is both an employee and a shareholder. He is rewarded for his efforts differently in the two capacities. As an employee he should be paid a reasonable compensation for services performed. As a shareholder, he should be rewarded with dividends which are really distributions of earnings (a return on investment).
The tax consequences of wages versus dividends are very different in a closely-held Sub chapter C corporation. Wages are fully deductible to the corporation, and FICA/Medicare taxes are withheld and matched by the company. The W-2 is prepared and treated as any ...
The solution explains the problem from the perspective of the IRS including the tax consequences of the reclassification of compension. Further, the problem gives a list of four actions a company might take to avoid the issue of disallowed compensation to the owner of a closely held corporation.