Software of the Month Club 1996 May/Software of the Month Club 1996 May.iso/mac/ISO9660/ZIPFILES/SBA962.ZIP/F105.SBE

Text File | 1996-02-15 | 4.5 KB | 99 lines

@043 CHAP 8

           ┌─────────────────────────────────────────┐
           │   "UNREASONABLE" COMPENSATION PROBLEMS  │
           └─────────────────────────────────────────┘

Some closely-held C corporations try to escape from being
caught between a rock and a hard place (between double tax-
ation if dividends are paid, and accumulated earnings or
personal holding company penalty tax if income is accumu-
lated in the corporation) by raising the compensation paid
to the employee-owners (or their relatives on the payroll)
to levels high enough to zero out the corporate income.

This works beautifully until the IRS audits the corporation
and decides that the compensation paid is unreasonably
high, and disallows part of it.  In that case, unless one
can convince the IRS (or a court) otherwise, the excess
compensation is treated as a constructive dividend and is
still fully taxable to the recipient, but not deductible to
the corporation.  This can also have other disastrous side
effects, such as disqualifying a pension or profit sharing
plan, where the contributions to the plan by the corpora-
tion were based on the "unreasonable" compensation, rather
than the lesser amount the IRS allows as a compensation
deduction.

@IF117xx]Because your business is structured in the form of a C corp-
@IF117xx]oration, you should be aware that some careful tax planning,
@IF117xx]in ADVANCE of the problem, may be needed it you become "too"
@IF117xx]successful and the issue of unreasonable compensation arises
@IF117xx]for you or other officers of @NAME.
@IF117xx]
S corporations generally do not have to worry about "un-
reasonable compensation," although if compensation paid is
too low, the IRS may impute a higher level of salary ex-
pense, which reduces an S corporation's net income, and is
thus a wash, overall.  The IRS will sometimes make such an
adjustment in the case of an S corporation where a parent
who runs a business has given stock to his or her children
and takes out little or no salary so that the corporation
will have more taxable income to be split with the children.
Or the IRS may argue that compensation is too low where an
employee-owner of an S corporation takes little or no sal-
ary in order to avoid FICA and/or unemployment taxes. (There
will be no such payroll taxes if he or she takes all of the
S corporation's income out in the form of dividends, rather
than compensation, unless the IRS forces a recharacterization
of the "dividends" as disguised salary.)
@IF118xx]
@IF118xx]@NAME is an S corporation, so you have
@IF118xx]relatively little to worry about on this issue of unreason-
@IF118xx]able compensation, except from the possible standpoint of
@IF118xx]taking too LITTLE compensation out of the corporation, as
@IF118xx]noted above.

A similar re-allocation of partnership income can occur in
a "family partnership" where there is an attempt to allo-
cate partnership income to children who have not earned it.
Sole proprietors don't have to worry about "unreasonable
compensation" unless making payments of salary or wages to
family members who do not earn the compensation.

@IF115xx]Thus, you are not likely to have to be concerned about any
@IF115xx]problems of "unreasonable" compensation, due to the fact that
@IF115xx]@NAME is a sole proprietorship.


NEW MILLION-DOLLAR LIMIT ON COMPENSATION

The Revenue Reconciliation Act of 1993 (also dubbed the
Deficit Reduction package) contains a provision you may have
heard of that disallows deduction of payments of over $1
million in compensation a year to certain corporate execu-
tives.  If yours is a small business, you probably will not
have to worry about this limitation, since you aren't likely
to be taking a million dollars a year in salary out of your
corporation.  Even if you are, this new limitation on compen-
sation deductions (which goes into effect in 1994) only
applies to:

  . "Publicly-held" corporations; and

  . Only to compensation paid to the top five executives
    of the corporation.

Finally, there are numerous ways around the limitation even
for the top 5 executives of a public company, such as payments
into a retirement plan or for other fringe benefits, and for
compensation based on performance, such as commissions, or
compensation that meets certain "outside" director and share-
holder approval requirements.

In short, don't lie awake at night worrying about this new
$1 million limit on executive compensation.  Almost no one
will be affected by it.