IRS Overlooked Billions in Taxes from S Corporation Shareholders

The Internal Revenue Service has stepped up efforts to collect employment taxes from S corporation officers, given that S corporation shareholders have gotten away with avoiding billions of dollars in taxes using a particular tax strategy for many years.

S corporation shareholders have been leveraging a tax break stemming from the Tax Cuts and Jobs Act of 2017 that enables them to save millions of dollars in taxes by being paid in profits rather than salaries, which costs the Treasury billions of dollars in revenue. The strategy leverages the lower tax rates under the TCJA, where profits are taxed at a top rate of 29.6%, as opposed to salaries being taxed at up to 37% (plus additional Medicare taxes).

S corporation shareholders have been leveraging the strategy for a number of years predating the passage of the TCJA. An analysis that was part of a new report, released by the Treasury Inspector General for Tax Administration found that single-shareholder owners made profits of $108 billion and took $69 billion in the form of a distribution over a given period, without reporting they received officer’s compensation for which they would have needed to pay Social Security and Medicare taxes. TIGTA estimated 266,095 tax returns may not have reported nearly $25 billion in compensation, allowing business owners to avoid paying approximately $3.3 billion in FICA taxes.

We anticipate continued exploration in this area from the IRS in the future.  Accordingly, S corporation shareholders and their tax advisors need to be mindful of these conversations within the IRS for future tax planning purposes in order to avoid any adjustments of tax returns by the IRS that, in addition to generating additional taxes, could result in penalties and interest.

The information presented here should not be construed as legal, tax, accounting, or valuation advice. No one should act on such information without appropriate professional advice and after a thorough examination of the particular situation.