January 2010
Tax Compliance of S Corporations
Last month the U.S. Government Accountability Office (GAO)
issued a report on its findings associated with the tax
compliance of S Corporations. The report focused on the
2003 and 2004 tax years.
The December 2009 report on S
Corporation tax compliance is one in a series of reports
issued by the GAO on the “Tax Gap” - the difference between
the amount of tax that taxpayers should pay and the amount
that is paid voluntarily and on time. The IRS has
estimated that the Tax Gap may be as high as $345 Billion –
about a 16 percent noncompliance rate.
Findings
Among other things the GAO’s recent
report states, “In 2003 and 2004, a majority of S
Corporations were noncompliant with at least one tax rule…”
The report went on to say, “For those years, the overall net
misreported amount…that S corporations passed through to
individual shareholders was about $85 billion.” And, using
a conservative estimate, the report indicated that for the
tax years 2003 and 2004 the misreported amount resulted in a
loss in tax revenues of $8.5 billion.
The most common errors involved
deducting personal expenses as business expenses. These
included payments for personal taxes, personal tax
preparation, personal insurance, personal vehicles, and
other personal expenses.
In addition, the GAO report indicated
that about 13 percent of the S corporations studied paid
inadequate compensation to their shareholders, resulting in
just over $23.6 billion in underpaid wages. The
underpayment of compensation avoids the payment of
employment taxes. The report estimated that the
underpayment could have resulted in a loss of tax revenues
of $3 billion for 2003 and 2004.
The report also cited mistakes
in the calculation of shareholder basis. The
calculation of basis has an impact on the amount of
corporate losses that may be passed through to shareholders.
Errors in the calculation could potentially understate
shareholder taxable income. The report pointed out,
however, that calculating and tracking basis was one of the
biggest challenges for shareholders.
Recommendations
The GAO made specific
recommendations. These include the following:
·
IRS should provide additional guidance to new
S corporations on calculating basis and compensation.
·
IRS should require examiners to document
their analyses of compensation, and provide more guidance on
compensation.
·
Congress should require S corporations to
calculate and report basis for their shareholders.
In light of the GAO’s report and
surging federal budget deficits, S Corporation shareholders
may look forward to new legislation and additional oversight
by the IRS.
Questions may be directed to Vincent Ruocco, LLC, CPA at 203.932.2931.
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