Three Common Errors, S-Corporation Shareholders and W-2s

Written by Peter Tran

June 28, 2017

S Corporations are the second most popular form of doing business in the United States.  According to the IRS, there are nearly 4 million S corporations in the United States, second only to sole proprietorships.  From the year 2000 to 2006, the number of S corporations in the United States grew by approximately 35%.  There […]

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S Corporations are the second most popular f of doing business in the Unit States.  According to the IRS, there are nearly 4 million S corporations in the Unit States, second only to sole proprietorships.  From the year 2000 to 2006, the number of S corporations in the Unit States grew by approximately 35%.  There are now twice as many S corporations as C corporations in the Unit States.  Tax returns fil by S Corporations, F 1120S, account for 70% of corporate returns fil with the IRS. 

Why S Corporations are Popular:  There are three basic reasons S Corporations have grown in popularity.  These include:

Increasing Scrutiny:  S Corporations can be a beneficial f of business entity – benefits which can include tax savings, so long as the rules that govern S corporation taxation are follow.  Failure to follow these rules, however, is why a growing number of S corporations and their shareholders find themselves increasingly scrutiniz by the IRS.  This increas scrutiny stems from the Treasury Department’s increasing effectiveness in matching the items report by S Corporations to the tax returns of their shareholders. 

Three Common W-2 Errors
Although there are many ways shareholders can run afoul of IRS rules, this column will look at three of the most common which impact W-2 reporting:

Error 1:  Reasonable Wage:
As mention above, one of the benefits of S corporation ownership is the potenl ability of the owner to uce employment .  Perhaps the most common and potenlly costly mistake made by S corporations is failing to pay a reasonable wage to shareholders for services provid to the business.  Noncompliance in this area is so pervasive that the Treasury Inspector General stat the following in a 2005 report (2005-30-080):

A 2009 General Accounting Office Study (GAO-10-195) reinforc the ne for increas S Corporation scrutiny when it found that in 2003 and 2004, S corporations under-report owner compensation by over $24 billion.  Considering the tax revenues lost due to non-compliant S corporations, the growing national debt, and the size of the Tax Gap (a measure of tax revenues lost due to noncompliant tax payers) it is really no surprise that S corporations are becoming the focus of increas enforcement efforts.  This focus is expect to become even more target due to the impact wage calculation has in calculating the new 0.9% Mie Surtax and the 3.8% Net Investment which are part of the Affordable e Act.

Avoiding Scrutiny:  Although we do not have time in this article to discuss calculation of a reasonable wage, the easiest way to avoid the reasonable wage issues is to answer the following question:  If you perf services for an S corporation in which you have an ownership interest, how much would you pay someone else to perf the same services?  Pay yourself at least this amount.  To substante the wage you choose, do some research (there are a number of online earnings survey websites) on how much someone perfing the same services are paid and document the results. 

The worst action you can take is to pay yourself nothing.

Error 2:  Personal Use of Business Auto
A second area that S corporation shareholders run into W-2-reporting-trouble is failing to report the personal use of business-own autos as taxable wages on F W-2.  With limit exceptions for certain types of vehicles such as certain delivery trucks, fire and law enforcement vehicles, and buses, the personal use of an employer’s vehicle is taxable income to the employee and should be report as compensation on both F 941 and the employee’s W2.

The owners of businesses that perf certain professional services should be especially eful when depreciating and expensing a business-own auto.  Although many types of businesses such as those involving and insurance, may require substanl driving, an auditor may become extremely critical of an owner-shareholder claiming 100% business use of a passenger vehicle: Claiming that they have never driven the vehicle home, stopp by the grocery , or pick the kids up from soccer practice is questionable. 

Protecting Yourself: The easiest way to avoid the IRS denying your business auto expense and re-characterizing it as taxable wages is to properly report the personal use of a business vehicle as taxable compensation on F W-2.  There are three basic rules that govern the calculation of taxable compensation resulting from the personal use of an employer-provid vehicle: the Cents-Per-Mile Rule, Commuting Rule, and Lease Value Rule.  These rules are too complex to discuss in this column.  What is important, however, is that you recognize the ne to track and report non-business use of a company vehicle as compensation on this year’s W-2.

Error 3:  Health Insurance
The final error made by shareholders (in this instance, those who own 2% or more of the S Corporation) on their W-2s is that of failing to include the value of their company-paid health insurance premiums in Box 1 (Wages, Tips and Other Compensation) and Box 14 (Other).  Although the premiums are not subject to Social Security and Mie tax, they are report as income on the shareholder’s personal return.  The shareholder can then duct the premiums as an adjustment on page one of their F 1040.  Failure to report health insurance in this manner can result in the premium duction being deni on the shareholder’s return.

This article has briefly discuss common errors S corporation shareholders make when reporting compensation on their F W-2.  For more infation on the taxation of S Corporations please read my articles: S-Corporation, Loss Deduction Danger and S Corporations, The Good, The Bad, The Scary.

Please remember: This or any article does not constitute or replace the advice of a qualifi professional.  If you would like assistance with your S corporation or any issue, please feel free to call our office at (304) 267-2594.

 

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