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Viewpoints: Letters / Opinions


By David G Hanger, EA, MBA

February 10, 2019
Sunday PM

There are only three classifications of individuals who are licensed to practice before the Internal Revenue Service and/or the Tax Courts of the United States. These are enrolled agents, attorneys, and certified public accountants (CPAs). All licensed practitioners have client privilege (which is to say what you say to them is between you and them only), rights of representation on behalf of their clients before the Service, and the ability to negotiate directly with the Service on an independent basis on behalf of one’s client. Those who call themselves ‘tax preparers’ or the even more euphemistic ‘tax professionals’ have no such rights or privileges, and in fact can and will be compelled to testify against you in a court of law. All three licensed categories require the passage of barrier exams that on average less than 20% pass annually. In the case of enrolled agents a two-year Federal background check is also required because such individuals are licensed to practice in all 50 states, as opposed to state licensing for the other two categories (reciprocity is granted by many states, but not all). Licensed practitioners are licensed under oath to only and to at all times operate within the limits of the law. That is the whole idea of the licensing, to guarantee to the public that these individuals are honest people whose advice and counsel can be trusted to NOT VIOLATE THE LAW.




There is no rocket science here; it is a very simple scam, and because it is simple it is also very simple to police (we will get into that more later). Many of the court cases dealing with this scam (there are lots of them) that are frequently cited originated with CPAs or Public Accountants who were gaming the system for themselves. (A further reason, by the way, why what is most egregious about this is that it is a conscious and intentional design on the part of so many who are specifically licensed not to do this kind of crap.)

Here is how simple the game is. Using a Subchapter S corporation, rather than paying salary or paying a miniscule salary (the two essential scam variants) all or most of the profits of the corporation are kicked out and reported as dividends, on which no payroll taxes are collected, thus on the first $128,400 x how many worker/shareholders, under current tax law for this year $19,645 is saved per worker/shareholder whose share is this much. Man, now there’s a scam; we all want some of this. There is at least one CPA in this town gin-milling this stuff, and on what I have seen of his work he is reporting no salary at all. Others here and elsewhere opt for the miniscule salary scam, which I must emphasize is just as egregious.

The reality of this conduct works out like this. You the taxpayer are naturally motivated not to want to pay $15,000 in payroll taxes on every $100,000 you pay yourself. So when you find an individual so lacking in integrity that despite his or her licensing they offer you a magic bullet, oh, are you ever so willing to jump through that hoop. Not only that, but then you brag to your friends and neighbors about the new whiz on the block that makes all the honest practitioners look like nothing. In ultimate, the crook puts all the honest practitioners out of business, because only he or she has that ‘magic bullet.’

In the words of a CPA who has both brains and integrity: “S corporation shareholder-employees and their tax advisers often find themselves with differing goals when setting the shareholder-employee’s compensation. Typically, the shareholder-employee prefers to minimize compensation in favor of distributions to reduce payroll taxes. Tax advisers, however, are faced with a body of governing authority providing that the shareholder-employee cannot avoid the imposition of payroll taxes by forgoing reasonable compensation. Unfortunately, until recently this governing authority had offered little in terms of how to actually compute reasonable compensation, leaving tax advisers with sparse guidance upon which to rely when recommending salary amounts to their clients.” (1)

Here is the open door, the loophole, on which all of this is based. A shareholder-employee of a Subchapter S corporation must be paid on a W2 “reasonable compensation” for the role or the work performed. Only after such “reasonable compensation” is paid can any distributions be defined as dividends. Until recently the meaning of “reasonable compensation” has not been defined by the courts, but recently in this instance means 1997 to 2006, so no CPA or other licensed practitioner can claim lack of awareness of the law.

From a prominent attorney: “Although the result of taking distributions instead of wages may seem enticing for the S-Corp owner/employee, there are a number of potentially serious consequences for taking this approach. FIRST, IT IS ILLEGAL UNDER THE TAX LAWS. (Emphasis mine) Second, it could prompt or increase the chances of an audit. Third, there is a potential for a hefty negligence or even fraud penalty. Fourth, once the IRS realizes what the owner/employee did, it will very likely reclassify some or all of the owner/employee’s distributions as wages. This will result in 941 and 940 (employer withholding tax) liabilities for the S Corp, plus penalties and interest.” (2)


Or as our prominent attorney puts it in closing: “Finally, it is a good idea to seek advice from a qualified tax professional. Just be careful. I’ve had an astonishingly high number of S-Corp owner/employee clients whose CPA advised them not to pay themselves wages (while taking distributions instead). IF YOU ARE AN S-CORP OWNER/EMPLOYEE AND YOUR CPA HAS GIVEN YOU SUCH ADVICE, CONSIDER TERMINATING YOUR RELATIONSHIP WITH YOUR CPA AND GET A SECOND OPINION. (Emphasis mine) If you are taking significant distributions and no wages, the IRS likely will not be lenient with you even if you were following the advice of a professional. If, on the other hand, you are paying yourself wages that are at least arguably reasonable and the amount of those wages was recommended to you by a tax professional, I would expect the IRS to be relatively lenient if it starts to analyze the reasonableness of your wages and determines that your wages are too low.” (3, Ibid.)

Our attorney uses the word ‘professional’ loosely. I prefer the term ‘licensed practitioner’ because it is quite specific, and that, of course, is what our attorney means. Otherwise, duly note that our attorney is referring to his clients who are his clients because some CPA screwed up, and he has a large volume of this work.

End. Part 1. The basic presentation is concluded. Part 2 details how and when to legally use a Subchapter S corporation to reduce your taxes. IT DOES PAY TO BE INTELLIGENT, BUT IT DOES NOT PAY TO BE STUPID AT ALL.

Part 2.

Taking some not all is probably as wise advice for taxes as it is for life, but as we live through an era of extreme moral relativism problems do emerge. If Jared Kushner, for example, earns last year $345 million and pays not one dime in tax, and we are told otherwise by those in power that only suckers pay taxes, does that imply that anyone who does pay taxes is just an idiot and a rube? Sure sounds that way. Thus there is plenty of incentive in daily public discourse for maximum tax avoidance, and I would be among the first to say, “I understand.” Yet while this is in small part a philosophical concern, it is primarily political, and so long as the voters continue to elect the super-rich and their minions who in turn create tax laws that favor them only (yeah, they’ll toss you a dog biscuit), the burden of tax will remain as it is. So outright and transparent violation of the law remains the ultimate in stupidity.

But if we use the analogy of a football season to describe the playing field upon which the gamesmanship of tax avoidance is played, we run into something very odd right away. For though there be boundaries to the playing field, and rules that dictate how the game is played, for all of the hundreds of games played in the season there will only be one referee for one quarter of one game. The rest will be sheer bleeping chaos.

A major part of current tax practice involves the reality just aforementioned. In the minds of some the question is simple. If there are hardly any referees, why not cheat? Let’s roll the dice and hope enforcement looks in another direction. Seems likely enough given conditions. My understanding is HUD (Housing & Urban Development) has had a total of seven audits since 1979 of the folks who provide low-cost housing, thus HUD has become a big money center for dirt bags. If no one is looking, they take millions; not a joke.

SO WHY NOT YOU? No particular reason except it is against the law. If you are one of those who wants to find someone to cheat for you, and you are willing to finance that individual with your business, I am sure you can assist him in making his cheating business grow. There will be plenty of others to follow your little primrose path. Most assuredly that will be convenient to the rest of us.

In terms of auditing this stuff it is actually rather simple. The IRS does not even need to send out field auditors. You either did it or you didn’t, so all they need to do is stack up cases on a desk and start sending out dunning and penalty notices. There is no digging through receipts or analyzing organizational structure or anything complicated; you either did or did not pay yourself a salary. That is blatantly obvious on the tax return that is filed.

So all of you folks who want to cheat that way go right ahead and stick with the guy who does that kind of stuff. That way you are all in one basket and easy to find. After cleaning you out the IRS might not even bother the rest of us. So pile on there, folks. Go for it. That is convenient to the rest of us.

Let’s describe the reality of how this works. Lightning does not strike everywhere, nor does it for extended periods of time strike at all. You might get lucky. And you might run into some wise ass who says, “Hey, we’ve been doing this the last three years and nothing has happened. These other guys don’t know what they are talking about.” (Again, the magic bullet.) Oh yeah. Funny thing is Uncle Sam likes to work kind of like lightning works, sometimes not striking at all for extended periods. And then,…………..BOOM!!!

So let’s say there are four of you, and you have mickey-moused your Subchapter S corporation, paid out only dividends, and have thereby “saved” $7500 a year X 4 = $30,000 for a period of three years = $90,000. In said instance if the IRS intervenes, all of your dividends (distributions) will be re-classified as salary, your base assessment for additional tax will be $90,000, and the penalties will come close to equaling that amount. Call the total bill $175,000 compounding daily. A recent article indicated that a middle class person needs 15 to 20 years to pay back $20,000 if they get behind, and individually you just more than doubled that. In essence you are cooked for life unless you have deep pockets nearby. THAT IS A HELL OF A LOT OF RISK FOR SOMEONE TO PUT ON YOU TO ENHANCE HIS OR HER REPUTATION. But in final analysis it is up to you.

One final and very serious problem with this is you will not find that many CPAs who are inclined to be this extreme, thus if you are a client of such a CPA, you are in fact wandering around with a target on your back. If they flag one account, there is considerable incentive to flag them all.

Which brings us at last to the ‘miniscule salary’ or ‘small salary’ scam. Many CPAs and EAs (actually have seen these folks in some instances do this, too) randomly assign a salary in the $20,000 to $50,000 range ($30,000 is a very popular number here) as ‘reasonable compensation’, then kick out $50,000 to $100,000 in dividends, saving on average $7000 to $12,000 per individual. Another method is to take whatever the annual net profit is and divide it by two. These are not acceptable standards, and significant adjustments not in your favor will be made.

Establishing ‘reasonable compensation’ for any job classification is actually very simple. Do a Google search and you will know everything you need to know in well under five minutes. If you go to court with the IRS, they will bring in a metrics expert who will go through a whole series of tests that will ultimately serve to validate what you learned in your Google search. The IRS determines the non-depreciable land portion of a property by going to the local property tax assessment and taking the proportionality between the land value and the improvements set by the local assessor. Likewise, the IRS will go right to the internet to establish a salary range for any job classification. So stick with the conventions that will clearly be used, at least to begin.

At this juncture a brief sidebar about ‘advocacy’ is necessary. As licensed practitioners we can as readily be disbarred or suspended from practice for not advocating our client’s position. Advocacy, however, does not include kamikaze acts, and a $30,000 salary in this day and age generally is way too low. There are both standards and precedents for all of this under law, so advocacy is compelled to deal with what the law allows.

Advocacy in this instance means that if the range of prospective salary is say $40,000, it is the obligation of the accountant to apply reasonable standards, but to otherwise encourage the client toward the lowest possible number with which the client is comfortable, understanding going in that there is a range of risk no matter what “reasonable compensation” number is chosen. This is further reinforced by the moral climate in which we currently are all operating.

Note that this payroll tax dodge is only substantively consequential on the first $128,400 of salary, on which 15.3% for social security and medicare is collected (these are the payroll taxes, and this does not include income tax withholding, a completely different subject). So in effect it is a poor man’s game; the super-rich have no real reason to play except to avoid 2.9% medicare on pass-through income which is only substantive if there are six, seven, or eight zeroes behind any other number involved.

Thus it has become a means by which many accountants seek to justify their existence and jack up their salary doing additional paperwork when it is neither necessary nor wise. But human greed being what it is, many a fool is willing to profit an extra $10,000 now even though at risk for forking out $30,000 later. Lightning only strikes in certain places, and only at certain times, eh!! There are any number of CPA (and others) gin-mills on the internet advertising their prowess with Subchapter S corporations for the old payroll tax dodge, somehow not realizing that this is like a pimple. It has been going on for decades, and only occasionally comes to a head with a new round of accountants who think they have found Wonderland. The bursting of that bubble is not pleasant.

Yes, you can in some instances benefit legitimately with the utilization of a Subchapter S corporation for your business, and I can assure you where relevant and applicable I will certainly encourage an individual in that direction because I, too, make more money; quite a bit more in fact. I will, however, only go in that direction if it will benefit the client while not putting said client at inordinate risk. To do it for the purpose of increasing my bank account I consider unethical. A lot of current practitioners no longer accede to that older ethical standard.

Start with the concept with which this presentation section begins, “Take some, not all.” $19,645 is the total social security take on the limit of $128,400. So if you had four owner/employees earning that much, if they tried to kick it all out as a dividend, they would save a bit less than $80,000 in aggregate.

But 80%+ of all Subchapter S corporations are one-owner operations, so the maximum tax avoidance available is $19,645 for all of those.

The question, therefore, becomes is the business operation consistently making enough money to pay out ‘reasonable compensation’ to its owner/employee plus enough money to pay out a dividend to its owner/employee that is substantial enough to justify the effort? That is not that easy a test to pass, but it is useful in some cases. These gin mills will report out profits of less than $50,000 as all dividends when in fact it is all W2 ‘reasonable compensation’ by law. Folks making less than $50,000 don’t need to be exposed to thousands of dollars of IRS penalties just for the privilege of paying some accountant an extra $1500 or more a year.

For all of these smaller owner/employee operations where the earnings are $50,000 or less Subchapter S treatment is not merely inapplicable, it is a fraud if the purpose is otherwise to merely avoid the payment of payroll tax. In other words it is not merely useless, it is also stupid. Only the entity collecting the fees for the extra paperwork is making off here. (I find it odd that so many who hate bureaucracy create so much unnecessary bureaucracy in their own lives.)
For those who have historically been abusing this to avoid payment of payroll taxes we turn to accountants, attorneys, doctors, dentists, and a handful of high-tech job categories where the salaries exceed the social security limit. What the court will do in virtually all of these cases where someone attempts to minimize their ‘reasonable compensation’ will be to define that compensation as $128,400, allowing some leeway on the 2.9% to infinity charge for medicare. For example, the experienced accountant’s salary range in this area is $89,000 to $212,000, so the court will not find it difficult if one made $150,000 to define all of that as W2 ‘reasonable compensation,’ but the court might cut you some slack on the last $20,000 or so.

So while there may be other reasons for a doctor or a dentist or an accountant to set himself up as a Subchapter S corporation, dodging payroll taxes is basically null and void. Indeed, if such an individual’s business is doing that well, he or she should probably incorporate as a ‘C’ corporation, pay a maximum 21% on earnings, and retain profits (within reasonable limits) within the corporation.

Thus if your business operation is too small, there is no rational reason to operate as a Subchapter S corporation with the expectation of saving payroll taxes. If your job classification routinely pays a high salary, i.e. the old-line true professions, and a few new ones, there is no prudent expectation of saving payroll taxes operating as a Subchapter S corporation. Unless you like routinely skating on water.

There is this middling ground, and this social security limit number increases annually; next year it will be more than $130,000. The most logical trades locally are such things as electricians, plumbers, furnace repair, and welders, some construction operations (but far from all), and certain types of retail operations (but the need for cash reserves to maintain inventories often suggests ‘C’ corporation for these operations). Canneries and cold storages, sure, but fishing boats probably not. Sometimes you do not make that much money fishing, and with fishing there are other ways to skin a polecat, so messing with Subchapter S corporations probably does not make that much sense unless you are a big fan of “accountants making big bucks for doing a bunch of unnecessary paperwork.”

Basically, the income flow of the business operation needs to be at least steady from year-to-year with the preference that it increases annually far in excess of inflation. This effectively ensures that the money you spend and the extra hassle you endure as a Subchapter S corporation every year is in the long run worth it.

Every $10,000 that you pass out of a Subchapter S corporation to an owner/employee as a dividend that is under the social security limit saves $1500 in unpaid payroll tax. If you have $40,000 that you can legitimately pass out, you just saved yourself $6000 in payroll taxes MINUS THE COST OF THE EXTRA PAPERWORK. The extra tax work and annual reports will cost you at least $1500 annually, plus you have quarterly payroll reports and bookkeeping costs, software costs, etc. This is why I emphasize a stable income flow in the operation from year-to-year; cost effectiveness rapidly diminishes for low-end operations with large swings in profitability.

So my standard, which is a rational standard based upon both law and common sense, is if your job classification has a salary in the range of $50,000 to $90,000, add $10,000 to that number, and if there is enough company profit left up to $128,400, you might just save payroll taxes legitimately, or at least semi-legitimately, by setting yourself up as a Subchapter S corporation. Remember, a $10,000 reduction in payroll reduces payroll taxes by $1500, which is at least what you will need to cover the additional annual administrative cost of a Subchapter S corporation.

There are a fair number of job classifications involving self-employment that fall into the $50,000 to $75,000 range, so from $75,000 to $125,000 is $50,000 which saves $7500 in payroll taxes if kicked out as a dividend. There are, however, not as many self-employed operations locally making that much money. Those most likely to do so are shop operations like plumbers, welders, electricians, etc. A lot of the other trades have highs and lows, and the guys are bringing home $30,000 to $80,000. A Subchapter S will not legitimately help these folks avoid payroll taxes.

But if you do have a business that has matured to the point where its profits considerably exceed the salary for your job classification, a Subchapter S corporation can indeed provide you with some relief. In combination with the Qualified Business Income Deduction this number can equal as much as $10,000 to $13,000 per year per owner/shareholder over what you were paying for 2017; but about half of that is the new QBID deduction for which you will get credit as a partnership or Schedule C operation as well.

The key problem with establishing a salary for your job classification is these are often ranged. Job X has a pay range of $50,000 to $80,000, Job Y $70,000 to $110,000, Job Z $89,000 to $212,000, etc. This is where advocacy on the part of the accountant comes into play. The accountant should generally opt for the lowest number possible within this identified range, then try to reinforce that assertion by additional means. Most assuredly the IRS will opt for the higher number in all cases, but so long as your accountant is not trying to cheat, is not so stupid he or she cannot be bothered to read, and is not so corrupt and dishonest as to willingly and unhesitatingly violate the oaths and standards of his or her licensing, you stand a fair chance of winning your case with the IRS, or at least not suffer much in the way of damaging consequence.

Among the additional means that can be employed include identification of equipment usage in a business operation (one is entitled to profit from equipment usage), which is certainly applicable to many of the trades, and otherwise to split the Subchapter S between the two spouses. There really can be no question about the dividend paid to the non-working spouse; it is a dividend, not a wage. Of course, if divorce is a possibility, there are obvious other prospective consequences.

As benchmark to comprehend how this works our previously cited attorney has this: “Oftentimes, an owner/employee will not be able to nail down “reasonable wages” with pinpoint accuracy, and will, instead, come up with more of a ball park figure. For example, reasonable compensation for a particular owner/employee might be somewhere between $70,000 on the low end, and $110,000 on the high end. If this is the case, then the individual’s tolerance to risk will come into play. In this $70,000-$110,000 example, I would say that wages from 0-$50,000 would be extremely risky, wages from $50,000-$70,000 would be high risk, wages from $70,000-$90,000 would be moderately risky, wages from $90,000-$110,000 would be low risk, and wages over $110,000 would be almost no risk.” (4, Ibid.) “Almost no risk” is the most interesting category here because it points out that if your business earned a whole lot more than that $110,000 the IRS and the courts might still decide to elevate that “reasonable compensation” salary even further. Last year I met a highly-experienced hand making $68 an hour, which translates to $136,000 a year base. These numbers may be Davis-Bacon, but that is also a government standard, so there is some room even here for the government to play with you.

So even in this middling ground playing the Subchapter S game has its fair share of potential challenges, uncertainties, and risk. In this middling ground, nonetheless, I still think you seriously need to consider playing. The deck is not stacked against you. Enforcement authority is extremely short-staffed and seriously demoralized, and it has been that way for a decade at least. If everyone is pressing the envelope and you don’t, you are something of a fool. Your fundamental obligation is to your family, and if someone else is running off with all the cookies, you are not doing either you or your family a favor by being too conservative and too cautious.

The question of moral relativism also comes into play. You can be stridently strait-laced if you desire, but if that means you get run over by a bulldozer (or its moral equivalent), I do not consider it particularly practical. You have to push back, and I have to push back on your behalf, and part of that is indeed gambling that your case will not be one of those that gets pegged. But as a licensed practitioner who actually believes you want honest accountants and attorneys, I will apply the standards aforementioned in all cases.

In effect the outright cheats open the door for some of us to exploit the situation by pushing the envelope a bit because the outright cheats will be first in line when finally the hammer falls. And when that hammer falls, those who have made an effort to identify and pay “reasonable compensation” before angling to save some money on their taxes stand a good chance they will be ignored and their tax return “accepted as filed.”

Returns filed this year are subject to review into 2023, so I suggest all of you study the concept of “realism” in determining whether you think the way things work today will be how they are working after 2020. Just like any business all it takes in the IRS is a few new gung-ho department heads pressing a few new combinations of buttons on a computer keyboard and everything changes. Use of Subchapter S corporations as a payroll tax scam is costing the government way too much money, is among the top two or three costliest scams out there, and will at some point in time (probably in the not too distant future) receive maximum attention and maximum enforcement.

If you are playing with one of these gin mills, you already have a big target on your back. If your accountant is not insisting on ‘reasonable compensation’ either at all or in modest amounts, your accountant is either incompetent or a crook. Find another accountant. Fast.

David G Hanger, EA, MBA
Ketchikan, Alaska



1) Distributions made by a Subchapter S corporation are technically referred to as “distributions,” not “dividends;” but “dividends” is a term with which the lay person is much more familiar, and is thus used interchangeably in this article for purposes of clarity.

2) All articles cited are readily accessible on the internet, so that any prudent individual can follow up without reference to inaccessible source material.


1) “S Corporation Shareholder Compensation: How Much Is Enough?” by Tony Nitti, CPA, MST, July 31, 2011, as published in The Tax Adviser, page 1.

2) “Exploring the Consequences of Paying S Corporation Shareholders Unreasonably Low Wages,” by David K. Petzinger, July 23, 2014, as published in TaxFortress, page 3.

3) Ibid., page 5.
4) Ibid., page 5.

Further reading:

“How Trump’s Tax Policies Will Affect Subchapter S Corporations,” by Robert Huebscher, June 21, 2017, as published in Advisor Perspectives. Dated, hence of limited value, but nonetheless lists and discusses numerous changes affecting Sub S corporations.

“S Corporations and Salaries: An IRS Hot Button Issue,” by Stephen Fishman, J.D., at Some very good information in condensed form.

“S Corporations Explained,” by Stephen L. Nelson, CPA, PLLC. Mr. Nelson is an example of someone who is running a “cautious” Sub S gin mill. By this I mean he is fixated, in his particular case, on the notion that a $60,000 salary allocation is a reasonable foundation upon which to establish “reasonable compensation,” but his reasoning is specious. He has books and tapes that he is also selling. Because he is allocating a salary of $60,000 at audit his preparations will be in the middle to the low end of the stack, so the damage to his clients just depends on how deep the IRS goes; but while “cautious,” he is not applying reasonable standards. What is worthwhile about this article is the 3+ pages he starts with indicating sundry problems with Sub S’s, and otherwise how even a generally conservative practitioner can encourage both himself and his clients to try to skate on water.



Editor's Note:

The text of this letter was NOT edited by the SitNews Editor.


Received February 08, 2019 - Published February 10, 2019

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