Distributions to S shareholders held not to be salary.
In a 1994 district court case, taxpayers received their first victory against the IRS's attempt to characterize distributions made to S shareholders as wages subject to FICA FICA
Federal Insurance Contributions Act
Noun 1. FICA - a tax on employees and employers that is used to fund the Social Security system
income tax - a personal tax levied on annual income
and FUTA FUTA Federal Unemployment Tax Act (US) taxes. In an unpublished case, Davis, d/b/a Mile High Calcium, Inc., the court ruled in favor of the taxpayer, stating that the Service was arbitrary and capricious capricious adv., adj. unpredictable and subject to whim, often used to refer to judges and judicial decisions which do not follow the law, logic or proper trial procedure. A semi-polite way of saying a judge is inconsistent or erratic. in its attempt to characterize loan repayments and dividend distributions made to the S shareholders as wages subject to employment taxes. The court also awarded the taxpayer reimbursement for reasonable costs, expenses and professional fees incurred in connection with the litigation An action brought in court to enforce a particular right. The act or process of bringing a lawsuit in and of itself; a judicial contest; any dispute.
When a person begins a civil lawsuit, the person enters into a process called litigation. .
S corporations may be inclined to forgo the payment of salaries to shareholder-employees in favor of distributions in order to avoid payroll taxes Payroll Tax
Tax an employer withholds and/or pays on behalf of their employees based on the wage or salary of the employee. In most countries, including the U.S., both state and federal authorities collect some form of payroll tax. . However, the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. has consistently taken the position that S corporations cannot use this technique and this issue has been extensively litigated. In three of the more notable cases, Radtke, S.C., 712 F Supp F SUPP Federal Supplement (decisions of US district courts) 143 (DC Wisc. 1989), aff'd per curiam [Latin, By the court.] A phrase used to distinguish an opinion of the whole court from an opinion written by any one judge.
Sometimes per curiam signifies an opinion written by the chief justice or presiding judge; it can also refer to a brief oral announcement , 895 F2d 1196 (7th Cir. 1990), Spicer Accounting, Inc., 918 F2d 80 (9th Cir. 1990), and Dunn & Clark, P.A., 853 F Supp 365 (DC Idaho 1994), the courts ruled in favor of the Service's attempts to characterize distributions as salaries.
The Davis case involved an S corporation in which all of the stock was owned by a wife and husband (Ms. Davis and Mr. Adams Mr. Adam (1946) is the first novel written by Pat Frank dealing with the effects of a nuclear mishap causing worldwide male infertility. The work was initially published by J. B. Lippincott Company, but was reprinted once in 1959 by Pocket Books under the title Mr. ). The corporation was engaged in the operation of a lime slurry slurry,
n a thin mixture of insoluble material floating in liquid.
solids in suspension. Used as a method of feeding pigs—slurry is pumped through fixed lines and delivered to troughs by hoses equipped with gasoline pump fittings. brokerage business in Colorado and Utah. Mr. Adams was nominally president of the company, but had virtually no active participation in its day-to-day operations. Mr. Adams held other jobs for various companies in other locations, including working as a ski instructor ski instructor n → instructor(a) m/f de esquí
ski instructor n → moniteur/trice de ski
ski instructor ski n , a truck driver and a heavy equipment operator. Ms. Davis was company secretary, performing part-time clerical duties, including communicating with independent contractor A person who contracts to do work for another person according to his or her own processes and methods; the contractor is not subject to another's control except for what is specified in a mutually binding agreement for a specific job. truck drivers. Ms. Davis also made business decisions for the company and took a few business trips. It was estimated that Ms. Davis performed about 12 hours of work per month for the company.
During the years in question, all amounts distributed by the company to the shareholders were classified as either loan repayments or dividend distributions. Checks were often written to Mr. Adams and deposited in his joint checking account with Ms. Davis. On the Service's determination that Mr. Adams was an employee of the company, it classified all checks written to him as salary. The IRS did not consider the purpose of the payments or the identity of the person who ultimately received the funds.
In its decision, the court noted that the taxpayer had met its burden of proof in characterizing payments from the company as dividend distributions and loan repayments. Even though Sec. 3121(d) defines an employee in part as "any officer of a corporation," Regs. Sec. 31.3121(d)-1(b) provides an exception for officers who perform only minor services and who neither receive nor are entitled to receive remuneration. The court concluded that Mr. Adams clearly fell within this exception. Unlike the Davis case, the shareholders in Radtke, Spicer Accounting and Dunn & Clark provided substantial services to their respective S corporations. In those cases, the corporations argued that the individuals were not employees, because the amounts paid were dividends rather than wages. The corporations asserted that shareholder dividends should not be treated as wages in S corporations. Those courts disagreed, noting that the taxpayer bears a heavy burden in characterizing payments as dividends instead of wages, and salary arrangements salary arrangements,
n.pl the clear understanding between the dental professional and auxiliaries concerning the amount of money they will be paid, the increase in pay they may expect, and the time interval between pay increases. between closely held corporations Noun 1. closely held corporation - stock is publicly traded but most is held by a few shareholders who have no plans to sell
corp, corporation - a business firm whose articles of incorporation have been approved in some state and stockholders require close scrutiny. Since the shareholders performed substantial services for the S corporations, and did not receive reasonable compensation for such services other than dividends, the dividends constituted wages subject to employment taxes.
In the Davis case, the Service had also classified other payments made by the corporation to Ms. Davis as salary, regardless of the nature of the payments, the type and extent of services provided by Ms. Davis or whether her alleged salary was commensurate with the value of those services. It is important to note that the corporation originally did not characterize any portion of these payments to Ms. Davis as salary. The IRS wanted the court to use its "common sense" to determine the extent and value of Ms. Davis's services. The court concluded that the Service's calculation of Ms. Davis's salary for the years in question was without basis in law or fact. Undisputed evidence was presented by Ms. Davis showing that she worked about 12 hours per month for the company, and that the value of her services was about $8 per hour. (The value of her services was based on testimony from the company's accountant.) Thus, according to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. the court, the salary attributed to Ms. Davis should be based on those facts. Since the IRS did not present evidence as to the extent and value of Ms. Davis's services, the court had to base its findings and conclusions on the evidence presented, not on speculation. Although not expressly stated in the case, if the Service had provided evidence challenging the extent and value of Ms. Davis's services, it is possible the court could have arrived at a different conclusion on the value of those services.
The Davis case is significant in that it is the first taxpayer victory in this area. It is important to note, however, that in the other major cases on this issue the shareholders provided substantial services to their respective S corporations and all amounts paid to them were in the form of dividend distributions. Davis illustrates that the IRS does not have unlimited power to classify dividend distributions as wages subject to employment taxes. However, one issue yet to be addressed is the IRS's ability to claim that compensation should have been paid when the S corporation does not make any distributions to the shareholder for a particular year.