S Corporation Audits Increase 34% in 2006
IRS audits of small business corporations and wealthy individuals increased significantly in 2006. The IRS audited nearly 14,000 S-corporations in 2006, an increase of 34% from 2005. Partnership audits increased 15%. Nearly 10,000 partnerships were scrutinized by the IRS. The IRS seems to be placing more emphasis on auditing pass-through tax entities used by knowledgeable entrepreneurs.
Traditionally, sole proprietorships have been the most heavily-audited business entity. Unfortunately, many business owners have abused S corporations to avoid paying reasonable employment taxes. The IRS wants to rein that in.
With sole proprietorships and limited liability companies, an entrepreneur's net earnings are subject to self-employment tax. Only income paid to the owner as salary is subject to employment tax with the S corporation. Money retained in the business for growth or money paid as dividends avoids employment taxation. Entrepreneurs often save thousands of dollars a year in employment tax by operating their business as an S-corporation.
It's important for entrepreneurs to pay themselves a reasonable salary. This can legitimately save thousands of dollars a year. But, the IRS doesn't want to see zero salary and $50,000 taken out of the corporation as other distributions. That's a red flag. It's important for S-corporation owners to understand the concept of reasonable salary.
Underreported income and deductions taken for personal expenses are also scrutinized during IRS audits. Some small business owners don't properly report their full income and others claim tax deductions for expenses that aren't properly tax-deductible.
About one in sixteen individuals earning over $1 million per year was audited in 2006, an increase of 33%. Over 250,000 individuals earning over $100,000 per year were audited in 2006. It's estimated $350 billion per year in taxes goes uncollected because of tax evasion. The IRS collected $48.7 billion as the result of IRS audits.
Peter Hupalo, Author of
How to Start And Run Your Own Corporation: S-Corporations For Small Business Owners
For more information about "Reasonable Salaries"
S Corporations and Reasonable Salary.