During an employment tax audit of an S corporation, the IRS determined that wages paid to the taxpayer’s corporate officer were unreasonably low, and recharacterized portions of distributions as wages. The issue raised in a Chief Counsel Advice (CCA) is whether the audit involved an issue of worker classification. Corporate officers are statutory employees under IRC Sec. 3121(d)(1) . In addition, the taxpayer treated its officer as an employee by paying wages through a professional employer organization, and by withholding employment taxes. The CCA therefore concludes that the audit didn’t involve a worker classification issue, rather a reasonable compensation issue. The CCA further concludes that the Tax Court lacks jurisdiction to review amounts recharacterized as unreasonable compensation because the IRS did not make the determination on the basis of a worker classification issue as required by IRC Sec. 7436 . CCA 201735021 .
Why is this important? Physicians who are owners in an S-Corporation sometimes have a tendency to reduce their salaries in order to maximize their Sub S distributions. This audit just reminds you to take a reasonable salary based on the services your are providing on behalf of the corporation. In any event, you should at least be taking out enough salary to maximize your annual corporate retirement plan contribution.