Hamlet the Prince wrote:

- quote -

I might agree on some theoretical level. However, it appears
that the code-based sanctions related to frivolous positions
only apply to UNDERSTATEMENTS (not overstatements) of tax.

MTW

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Drew Edmundson wrote:

- quote -

Indeed. The "realistic possibility" standard is supposed to
be met at the time the RETURN is prepared, not at the time
the TAX COURT PETITION is prepared. <g
MTW

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MTW wrote:
- quote -

To the last question first, I don't have a cite, cause my
position is the same on Jan 5th as in october.

If client engages me to prepare the 1120S that's what I'll
do based on the historical facts. For that's all I'm
attesting to below when I sign the return.

Of course I'll advise him in January while there's still
time to characterize at least some of the distributions as
annual salary.

ChEAr$,
Harlan Lunsford, EA n LA

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- quote -

Your original post asked whether you had to treat ALL S-corp
distributions as wages. That is one end of the spectrum.
Above you are talking about the other end of the spectrum
(NONE of the distributions as wages). As with many things,
it is not always black or white. Depending on the
circumstances it may be frivolous to file a return at either
end of the spectrum.

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- quote -

I think you make a plausible argument, although I don't
think it's a slam dunk. Where he sells his practice
for $1,000,000 (very high for a $300k practice but, as
you said, the numbers are made-up), the business still
needs the doctor to perform all of the services to
produce a penny of income.

Typically a doctor sells his practice because he is
retiring or leaving town, and the typical purchaser is
a new doctor or one new to the market. The seller can
command a price because the buyer will be able to have
a more or less full practice right away.

Assume that a young and competent doctor moves to town
and starts his practice from scratch. Patients like him
and in, say, three years, his practice is full. He
needed minimal capital to get going, but now makes your
assumed $300,000 per year. In the first year, maybe
he made $100,000 and maybe in year 2 he made $200,000.

On the other hand, assume that the same young doctor
purchased a practice from a successful doctor that was
retiring and already making $300,000 per year. If all
goes according to plan, the young doctor will make the
full $300,000 from day one, rather than taking three
years to get there. Typically the price works out to
where the doctor in effect pays about what he projects
his increased income will be for the first couple of years.
(A more realistic price in this example would be $250K
to $300K for the purchase price.)

In the first example, the doctor puts up minimal
capital and in year three makes $300,000, all
attributable to his services. In the second, the
doctor is making $300,000 for his work in seeing
the same number of patients as the doctor in example 1
(after year 3). Reasonable compensation is the standard
for the deduction for the doctor's compensation. Is the
reasonable compensation amount different for the same
hypothetical doctor, seeing the same number of patients
and making the same (after year 3) net income in either
case?

That said, I don't disagree with backing into a
reasonable compensation amount by subtracting a return
on the purchase price from the physician's net income.
On the other hand, an enterprising revenue agent might
be able to make a plausible argument that reasonable
compensation for the doctor is same amount whether
he bought the practice or built it up himself.

Brian Bivona, CPA

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Harlan Lunsford wrote:

- quote -

Hmmm... Well, permit me to ask: What would you do if this
client had come to you on (say) January 5th - that is,
clearly in sufficient time to prepare appropriate 941s and
W-2s for the prior year? And, if you would prepare the
payroll returns in THAT case (notwithstanding the fact that
the client failed to do so during the actual tax year in
question), what is it that changed between January 5th and
October 10th to cause you to change your recommendation?

And (you guessed it <g> ), can you cite AUTHORITATIVE SUPPORT
for your change of position?

MTW

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"MTW" <mtwingcpa[at]yahoo.com> wrote:
- quote -

I agree.

- quote -

I almost didn't respond to this one but I suppose these
folks are going to make the salary calculation upon audit.
Not an optimal approach.

- quote -

Here I have to disagree. There are plenty of "C" cases
where less than all the profit was treated as wages. So I
think it meets the 1 in 3 test.

- quote -

They have their returns prepared elsewhere.

--
Drew Edmundson

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Drew Edmundson wrote:

- quote -

Keeping in mind that we're discussing the highly theoretical
and subjective concept of "realistic possibility," which by
definition EXCLUDES practical considerations such as the
likelihood of settlement, I keep coming back to the
following:

1) Treating all (or substantially all) distributions as NOT
wages is a "frivolous" position and therefore flunks the
"realistic possibility" standard.

2) Given the progression of recent court cases, and the
complete absence of any other AUTHORITATIVE guidance to the
contrary, I'd say that a position based on an arbitrary
percentage allocation (but without invoking traditional
"reasonable comp" concepts) is ~borderline~ frivolous. In
any event, I believe it flunks the "one-in-three"
probability standard because, in fact, there is nothing
AUTHORITATIVE to support it.

3) Cases involving traditional reasonable comp issues have,
in my opinion, a realistic possibility. But, in my ~highly
subjective~ opinion, it has fallen below a one-in-three
probability standard. Again, the progression of the court
decisions has moved in a different direction. In the area of
S-corps, we see far more discussion about "substantial
services" than we do about "reasonable comp."

I don't think the "realistic possibility" standard is
intended to be an "audit lottery" concept. (Indeed, far from
it!) So, the mere fact that we haven't seen a case involving
(say) a 37% allocation to wages doesn't mean that there is a
realistic possibility of success at that level, or any other
arbitrarily selected level. There is no STATUTE or SUPREME
COURT CASE that officially requires or condones differential
treatment for "pigs" versus "hogs" (indeed, wouldn't
something like that violate the "equal protection"
concept?). So, in light of the AUTHORITATIVE materials that
are actually on the books, what is "realistic" (other than
wishful thinking) about anything less than 100% wage
treatment???

But, I concede, this is a highly theoretical level of
concern - and I doubt that I'll be able to change many
minds. <g
MTW

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Brian <bpbiv[at]yahoo.com> wrote:

- quote -

Consider this case (with arbitrary made-up numbers): A
doctor's practice earns (him) $300,000/year. When he
retires, he sells the practice for $1 million. That creates
the presumption that the business itself was worth the $1
million. Since the business itself had that value, a
reasonable return on that value (say, $100,000) was due to
the business, the rest should be treated as reasonable
compensation.

Seth

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MTW wrote:
- quote -

Here I must agree with my esteemed colleage, Phoebe in toto.
(no, not a Kansas dog! "entirely"

Picture this, Mike. client finally brings you "stuff" for
you to prepare her 2003 1120S return about.... on... October
10th. (after extension of course!) And leafing through her
books, you notice absolutely no salary for 100% shareholder
officer who devoted 100% of his time to the business.

What'cha gonna do?

1. Tell him "Take these books and shove em".
2. Agree to prepare the return if he'll belatedly file W-2's
which convert those distributions to salary and thus risk
penalties and interest which the client should pay?
Or
3. Prepare the return like Jack Webb of LA with "just the
facts, M'am".

I just don't think IRS would hold us responsible for what
client didn't do. The language "realistic probabilty" and
"return position" I believe refer to determination of
income, i.e. bottom line, and in this case (#3 above) would
result in MORE income shown on the return.

My comments of course are in re to circular 230 only and not
to any state board of accountancy strictures.

Maybe I've opened a can of worms here, but that's my story
and I'm sticking to it. If I don't see your reply by
tomorrow night, will pick up on it next weekend after
returning from my inspection trip of the battlefield at
Vicksburg and the two day tax seminar afterwards. (Why do
they hold these seminars at casinos?)

ChEAr$,
Harlan Lunsford, EA n LA

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Phoebe Roberts, EA wrote:

- quote -

I would agree with your point if, in fact, NO cash was
distributed to the officer-shareholder (either as wages or
as distributions). However, if cash was distributed, then
the characterization of it constitutes a "return position"
in my opinion. This, in turn, triggers the "realistic
possibility" standards of Circular 230 and similar
provisions in state board rules applicable to CPAs.

MTW

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Harlan Lunsford wrote:

- quote -

I don't have the complete cites handy at the moment, but the
case names are Spicer, Radtke, Veterinary Surgical
Consultants and Grey.

MTW

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MTW wrote:
- quote -


Remember however, that it is not our responsibility to make
sure a client pays shareholders what IRS MAY determine LATER
to be the appropriate salary. Indeed, the statistics cited
below by Gene re the average $5,300 salary indicates by
itself that any position has a reasonable basis on being
sustained (by default I admit).

Of course when I registered a surprise about sec 10.34 of
230 I was thinking only about my own case where I work for
my S corporation, so don't even employ an outside preparer.
(grin

ChEAr$,
Harlan Lunsford

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MTW wrote:

- quote -

yep, and that's the one I KNEW I had, somewhere, at the
office. And probably still do, but not to be found.

- quote -

You say "all cases in recent history... 100%... as wages?"
If you get a chance, please post these cites. You can
appreciate my interest, since mine is an S corp.

ChEAr$,
Harlan Lunsford

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"MTW" <mtwingcpa[at]yahoo.com> wrote:

- quote -

While the "max tax" is a thing of the past, it still
had at its core the concept of payment of reasonable
compensation. Certainly it would provide more
comfort to case law dealing with S corporations
paying too little compensation, but where there is
not a big body of law you can still draw some
useful parallels.

In situations where "ALL revenue-generating
services" are performed by officer-shareholders
I agree that it is normally difficult to make the
argument that less than all of the income should
be treated as reasonable compensation, although
there are probably some cases where you could still
sustain an position to the contrary. In professional
services such as doctors, lawyers and accountants
that have no associates that generate income, it's
going to be especially difficult. In situations where
the employee shareholder has to put up a
meaningful amount of capital, I think the case can
be made that some of the income should be
treated as a return on the capital, and can be paid
out as a dividend, rather than salary.

Brian Bivona, CPA

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MTW wrote:
- quote -

pay wages, then they didn't pay wages. If they took money
out with no intent to ever repay it, then they don't have a
loan. Our responsibility as preparers is *not* to report
what should have happened if our clients had made better
decisions, but to report what actually *did* happen.

"Taxpayer paid no salaries to officer-shareholders" is not a
position, it's a fact.

Phoebe

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MTW" <mtwingcpa[at]yahoo.com> wrote:
- quote -

I think the "reasonable possibility" comes from the "C"
corporation arena and from the fact that in most (AFAIK,
all) of the 100% cases the taxpayer took all profits as
distributions and none as wages.

--
Drew Edmundson, CPA (NC)

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Gene E. Utterback, EA wrote:

- quote -

Interesting indeed! It seems like every couple of years the
IRS hints at a possible crack-down in this area, but nothing
seems to happen.

MTW

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Harlan Lunsford wrote:

- quote -

See Circular 230 Section 10.34 and consider that your
license could be at stake. <g
MTW

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Drew Edmundson wrote:

- quote -

Yep, that's what I'm looking for. Like, a case where the
taxpayer treated (say) 30% of pre-salary profits as wages,
the IRS issued a SNOD setting the wage level at 80%, and the
Tax Court (in its infinite wisdom) eventually decided that
the correct allocation was precisely 62.587%. That kind of
thing.

But, I can't find it. It appears that ALL cases in recent
history that specifically address the issue have held that
100% of the distribution amount should be treated as wages.
So, if 100% of the cases treat 100% as wages, and there are
no code sections or regulations or other rulings to the
contrary, wherein is the "reasonable basis" or "realistic
possibility" or whatever that everyone claims to see in this
issue?

MTW

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