Are you concerned about the likelihood of increased IRS audits?
Are your clients concerned as well?
Do you know the issues the IRS will likely look at and are you prepared?
By understanding the potential issues of the following 3 entities, you will be better prepared and ready for potential audits. Understanding the areas the IRS will likely attack will help your clients become audit proof.
Let’s explore S corporations, C corporations, and Partnerships.
S corporations
As you know, this is the most common entity. One issue to be aware of is reasonable compensation. Remember, the general rule is your client must take a reasonable salary for what they are doing. Ask your client what they would pay someone else to do their job. For example, if you have a dentist or a chiropractor that owns their own practice, their salary should be what another employee would get if they did the same job. Your client is going to look to you for advice and help them decide on a reasonable salary. You could advise them to look at salary.com for suggestions.
Another issue the IRS will look at is shareholder basis. The IRS has stated they are looking at this and it’s an area most CPAs have struggles with. There needs to be a balance between equity basis and debt basis. Clients must make sure shareholder loans are documented. Your client can’t just take money out whenever they want to. They need a shareholder’s agreement. If clients want to take money out, they must have loan documentation in place.
Operating agreements are crucial to have documented properly. There are times where clients have not updated these and now the distributions become taxable because your client is really operating as a C corporation instead of an S corporation. Advise your client to find a tax attorney to update operating agreements if necessary. Every entity should have an operating agreement.
C corporations
The number of C corporations has grown since 2018. The number one C Corporation issue you will see is Section 1202. The IRS has already indicated that they are looking into this area. In these circumstances it’s recommended to have a tax opinion from a tax attorney. Other issues to be aware of (and that the IRS will likely be auditing) include reasonable compensation, related parties, and personal holding companies.
Partnerships
The IRS is already actively looking into partnerships and one major issue they’re looking into (that a lot of CPAs aren’t handling well) is partnership allocations in the real estate area. Other issues to be aware of to reduce your client’s audit risk include at-risk rules, basis, QBI, self-employment tax, passive activity rules, 1231 vs capital gain vs ordinary income, interest limitation, cost segregation, and sweat equity.
Remember, the IRS is always looking for documentation. 70-80% of clients are missing documentation. This makes it extremely easy for the IRS to disallow deductions. Your job is to prove your client’s deductions are deductible. The general rule is it’s not deductible and this is why you must prove it’s deductible by meeting these tests. You must make sure you can defend and meet your risk tolerance. Remember, your risk tolerance is not your client’s risk tolerance. Your risk tolerance is to be able to sign the tax return. Everyone has clients with varying degrees of risk aversity. Clients want to know how to make something deductible and your job as an advisor is to give them options.
Spending time educating yourself and exploring the issues the IRS will likely be auditing in these entities will help you become better prepared and reduce your risk and make you able to better advise your clients. Better educated CPAs = Better educated clients. When you have better clients, you will have a better practice and a better life. To expand your knowledge, please consider joining TFW Advisors® and book a call with us today!