S-Corporation AuditsS-Corporation Audits

Owen Dewing Owen Dewing

EA/CPA/CIFA/PEEA/CPA/CIFA/PE

• This Information is copyright protected by and may not be reproduced or This Information is copyright protected by and may not be reproduced or otherwise distributed.otherwise distributed.• This presentation is for informational purposes only and should only be This presentation is for informational purposes only and should only be implemented by a practitioner after appropriate due diligence has been implemented by a practitioner after appropriate due diligence has been performed.performed.• This advice in this course could eventually be incorrect at the time you This advice in this course could eventually be incorrect at the time you read it. Laws can change and so does the IRS. There will be changes to read it. Laws can change and so does the IRS. There will be changes to the tax code for TY 2008 and with a new administration and legislative the tax code for TY 2008 and with a new administration and legislative branch there are likely changes which you should make yourself and branch there are likely changes which you should make yourself and clients aware.  Check with a tax lawyer or an accountant if necessary.clients aware.  Check with a tax lawyer or an accountant if necessary.• Not all of the concepts and strategies proposed in this presentation may Not all of the concepts and strategies proposed in this presentation may be appropriate for all practices. Careful study must be undertaken by be appropriate for all practices. Careful study must be undertaken by anyone considering the implementation of these concepts and special anyone considering the implementation of these concepts and special attention should be given to individual state laws governing the practice of attention should be given to individual state laws governing the practice of professionals.professionals.

S- Corporation Audits• S Corporation Audits Increase 34% in 2006

• IRS audits of small business corporations and wealthy individuals increased significantly in 2006. The IRS audited nearly 14,000 S-Corporations in 2006, an increase of 34% from 2005. Partnership audits increased 15%. Nearly 10,000 partnerships were scrutinized by the IRS. The IRS seems to be placing more emphasis on auditing pass-through tax entities used by knowledgeable entrepreneurs.

• With sole proprietorships and limited liability companies, an entrepreneur's net earnings are subject to self-employment tax. Only income paid to the owner as salary is subject to employment tax with the S corporation. Money retained in the business for growth or money paid as dividends avoids employment taxation. Entrepreneurs often save thousands of dollars a year in employment tax by operating their business as an S-corporation.

• It's important for entrepreneurs to pay themselves a reasonable salary. This can legitimately save thousands of dollars a year. But, the IRS doesn't want to see zero salary and $50,000 taken out of the corporation as other distributions. That's a red flag. It's important for S-corporation owners to understand the concept of reasonable salary.

• There's an easy way to (almost) audit-proof your business.The IRS will not tell you this, but you can avoid quite a few tax tangles by

setting up your business as a partnership, LLC or an S- Corporation, rather than as a sole proprietorship.

• Did you know that sole proprietors who claim home office deductions hold up two red flags for the IRS?! They must file a separate home office deduction form, Form 8829, Expenses for Business Use of Your Home, and attach it to a Schedule C. Both Schedule C and Form 8829 attract IRS attention - especially if filed with the same tax return. If incorporated, however, either as an S corporation or a C (regular) corporation, you can take home office deductions without filing Form 8829.

• S corporations avoid much IRS scrutiny, too. One advantage is that people who pay income to the business don't have to file Form 1099s with the IRS when they deal with an S corporation. By contrast, Schedule C filers get 1099s from anyone who pays them at least $600 in a given year. A copy of these 1099s goes to the IRS. By electing the S corporation status, you'll have fewer pieces of paper with your name on them floating around IRS files. When you do business as an S corporation, you can pay yourself a "reasonable salary"--an amount that the tax code does not clearly define. Amounts earned beyond your reasonable salary are corporate earnings. Even though corporate earnings are subject to income tax, you won't have to pay Social Security and Medicare tax on them.

• Also make sure to get a tax payer ID for your business and not to use your personal social security number. It will reduce visibility of your own tax return a little bit.

• Second, the IRS is attacking S corporation compensation practices. In particular, auditors' eyebrows are being raised if salaries paid by an S corporation to its principal owner or owners look suspiciously low. This "troublesome area," as SB/SE Commissioner Brown calls it, involves a technique in which the S owner/employee draws a low salary to avoid employment taxes that ordinarily would be due on additional wages but would escape tax if passed through as dividends. Brown labeled this practice as "abusive" and warned that "IRS examiners are aware of the practice." Not only are IRS examiners disallowing this technique but they reportedly are also assessing 20 percent accuracy-related penalties. A review of W-2 income and total distributions received by the S corporation owner-employee during the year may be in order for many businesses.

CHANGES IN THE IRS OVER LAST DECADE• Reduction in staff at BMF and International

• Retirement of Skilled Auditors From the mid 1990’s on senior experienced staff have looked for other employment or retired. This has caused a significant “brain drain” in the existing staff of IRS.

• Training– new hires are being taught and trained by

individuals with less than three years experience. • New individuals – The newly trained auditors have less

training, less experience to draw upon, and a smaller pool to draw from internally.

» Political Issues – There have been changes in IRS over decades that deal with changes in Congress and the White House. This is also affected in IRS.

» Costs – IRS believes that even though there is a magnitude of more than 100 times more tax to be collected from BMF side of the house, less expense is incurred in going after the Schedule C tax filer.

Audit Risk for S Corporations • Today, S corporations are the most popular corporate form of

doing business, with nearly 60% of all corporations now filing Form 1120S, U.S. Income Tax Return for an S Corporation. Electing to be taxed as an S corporation allows corporate owners to report their share of corporate income, deductions and other items on their personal returns, avoiding a potential "double tax" occurring in regular, or "C," corporations. But the popularity of S corporations may be jeopardized by an IRS announcement in July 2005 that it was starting a new audit project focused on S corporations.

What Is The IRS Looking for? For many industries, the IRS can deduce income omissions by looking at

deductions claimed on a return. For example, if a pizzeria deducts a certain amount for the purchase of flour, the IRS concludes that it should have produced a set number of pies, resulting in reportable income of a certain amount. It has created dozens of audit guides for specific industries, from auto body repair shops to veterinarians (for access to these guides, go to www.irs.gov/businesses/small/article/0,,id=108149,00.html).

• Compensation paid to shareholder-employees. In S corporations there is a tendency to underpay owners in order to minimize Social Security and Medicare (FICA) taxes. From an income tax view, whether income is paid out as compensation or otherwise does not affect the taxation of the corporation or its shareholders, who report their share of corporate income on their personal returns.

But from an employment tax view, underpaying compensation for work actually performed is viewed as an impermissible way to avoid employment taxes. The courts have supported the IRS position that shareholders who work for their corporations must take reasonable compensation for the work they do.

** Deductions--excessive or inappropriate write-offs. Problem areas include taking deductions for items that should be capitalized (e.g., costs that should be added to inventory rather than separately deducted) and travel and entertainment expenses that lack the necessary records and receipts to support them.

How to Protect YourselfIf you received a letter from the IRS informing you of selection, don't panic.

Contact your tax advisor immediately. A tax professional knows how to proceed and what to say (and what not to say) during an audit.

You can also act to bolster the positions already taken on your return.

• Review recordkeeping. Make sure you have receipts and other documentation to support the deductions claimed on the return. Safeguard your information so you can make it available to the IRS if necessary. Since 2005, IRS is obliged to take your information from Neat Receipts. We are going to a paper reduction society and this will be a big help for your business. My clients are asked to keep records for at least seven years and I suggest they go to 10 years because if IRS audits before the “hurdle” date then you could need to go as far back as 10 years. If in your practice you do book keeping then you should start having your clients materials go on blue-ray or CD. We are heading to an electronic future.

• Set aside funds to cover audit expenses. Handling an audit can be very costly for your company. Hopefully, by taking this course you will reduce the likelihood that your clients will be audited. Create a war chest to pay your accountant or other tax advisor for handling this matter. Anticipate a minimum of approximately 40 hours of professional help to prepare for the audit, meet with IRS agents and follow up as needed. Depending on your advisor's hourly rate (typically $200 to $300 per hour, depending upon your location and advisor's expertise), expect to spend about $8,000 to $12,000--or considerably more if your tax situation is complex.

Tax Tips & Audit Strategies for S-Corporation Shareholders

• Reasonable Compensation - The number one audit risk for S-Corporations is salary and wages paid to officers of the corporation. S-Corporations are also subject to hobby-loss rules. Together these are the two most significant audit risks facing S-Corporations right now.

• The fastest way to get audited as an S-Corporation is to file an 1120S with no amount showing on Form 1120S Line 7 "Compensation of Officers." It is assumed by the IRS that no one works for free, and so the IRS has said over and over again that officers of the corporation must receive wages (reported on line 7). As an owner-employee of the S-Corporation, you must pay yourself a salary, and pay payroll taxes on your salary, even if the business is losing money. You don't have to pay yourself a high salary, but it must be a "reasonable amount" according to the IRS. Reasonableness can be interpreted in different ways. I would keep track of the number of hours you work for your business, and then figure out a "reasonable" salary to pay yourself based on the amount of time you spend.

• If your S-Corporation is losing money (especially in the first few years of operation), then your losses will be exaggerated by the salary you have to pay yourself. Thus, if your economic losses (not counting your salary) is $10,000, but you need to pay yourself a "reasonable" salary of $10,000, then your tax loss will be at least $20,765 ($10,000 economic loss + $10,000 salary + $765 in employer-paid payroll taxes). In an S-Corp, your tax losses will always be greater than your economic losses, and your tax profits will always be less than your economic profits.

What's a Reasonable Salary?

• Compensation of shareholder-employees should be based on the same criteria as salary for non-shareholders. Factors would include prevailing market rates; the individual's knowledge, skills, and abilities; amount of hours worked; and so forth. Salary is reasonable if a non-shareholder would be willing to accept the job at the proposed salary level.

• Example: XYZ Widgets is an S-Corporation with $2 million in revenue. John, the

shareholder of 60 % of the business also manages the operations. He thought he could get someone else to take the management position so he listed it in the paper for what he paid himself $10,000.00. The employment agencies and 12 major newspapers produced six enquires asking the compensation. Hearing it was “only $10,000.00” they all declined further interest. It is a good bet that the IRS would also suspect $10,000.00 is “low” for a management position with that revenue.

• Generally, the IRS will grant the S-Corporation a degree of latitude in setting salary compensation for shareholder-employees. However, the salary must be paid, and the level of salary must be appropriate.

****What's an Unreasonable Salary?****

• A] Zero salary is unreasonable. No one works for free.

• B] Salary below minimum wage is unreasonable. You would not persuade a non-shareholder to accept a job offering below minimum wage.

• C] Salary far in excess of an appropriate wage is unreasonable. Paying a million-dollar salary when an officer in similar position would expect to make only $150,000 is also unreasonable. Some S-Corporations have attempted to pay higher-than-normal salaries as a way to increase business expenses.

Why is Officer Compensation an Audit Priority?

• The IRS can collect payroll taxes on officer compensation, and the penalty for failing to pay payroll taxes is 100% of the taxes owed. S-Corporations will avoid this payroll tax penalty by paying shareholder-employees a reasonable compensation.

Example:• ABC S corporation does consulting work. They

receive $200,000 in income. It is run by an individual, Joan, who hires a secretary/associate and the S Corp has an EIN number. ABC has $20,000.00 in office expenses and $30,000.00 salary to the associate. Joan receives a salary of $50,000.00 by W-2. Then Joan receives an 1120S K-1 for $100,000.00 which goes to her individual 1040 tax return.

This will save Joan almost $10,000 in FICA!

Hobby-Loss Rules• An S Corporation is presumed to be a for-profit enterprise if

it shows positive net income in three years out of a five year period. Typically, that means an S Corporation should try to plan on having at most two loss years in any five-year period. Nonetheless, S corporations might be able to prove they have a profit motive even though they have more than 2 years of losses if they can show increasing sales, maintain

expenses, and project a profit in the near future.

Hobby vs. BusinessHow do you distinguish between a business and a hobby?• Generally, a hobby is an activity that is carried on for

personal pleasure or recreation. It is not an activity entered into with the intention of making a profit. In determining whether you are carrying on an activity for profit, all the facts are taken into account. No one factor alone is decisive. Among the factors to consider are whether:

• You carry on the activity in a businesslike manner• The time and effort you put into the activity indicate you intend to

make it profitable• You depend on income from the activity for your livelihood• Your losses are due to circumstances beyond your control (or are

normal in the startup phase of your type of business)• You change your methods of operation in an attempt to improve

profitability• You, or your advisors, have the knowledge needed to carry on the

activity as a successful business• You were successful in making a profit in similar activities in the past• The activity makes a profit in some years, and how much profit it

makes• You can expect to make a future profit from the appreciation of the

assets used in the activity• The importance of knowing whether you are involved in an activity for

profit or as a hobby is that the amount of expenses you can deduct if the activity is a hobby are limited to the amount of income from the same activity.

– Record keeping– Client needs

• Business Plan• Credit Card only for Business• Separate Checking Account

S corporation Benefits and Advantages

• Avoid an Audit! Become an S-corporation!

• Many business owners believe that the best way to avoid paying excessive taxes is to exaggerate their deductions or to not declare all of their income. WRONG!! In fact, these are the “RED FLAGS” that often trigger the Internal Revenue Service to audit your tax return to begin with. What a nightmare! An “audit” by the Internal Revenue Service or State Tax Authority can be a painful, time-consuming, money draining event that all business owners should be happy to avoid.

The best way to audit-proof your Form 1040, U.S. Individual Income Tax Return, is to remove as much information from it to another area where the chances of getting audited are greatly diminished. Typically, small business owners are steered to the single member LLC by an attorney. However, these attorneys are not doing their clients any favors and in most cases are forming an LLC simply because they heard everyone else is doing it.

• Here’s a fact. Small business owners are open to greater audit risk. If they are using a business entity such as sole proprietorship or single member LLC that requires them to report all of their income and expenses on Schedule C of their individual income tax return, they are exposing themselves to maximum audit risk. How can this be avoided?

S-CORPORATION!Here’s the information that your attorney doesn’t know to tell you! 6 Reasons why

most small business owners should be operating as an S-Corporation:

1. Your annual net income from your S-Corporation appears on one line of Schedule E of your 1040. Accordingly, there is no income or expense detail showing up that would trigger a “red flag” like there is on a Schedule C used for a single member LLC.

2. There is no disclosure of home office expense similar to that used on a Schedule C. On an S-Corporation tax return, home office expenses are combined with other expenses and no separate disclosure is required.

3. If you are a subcontractor for another business, use of the S-Corporation will help you avoid being issued a 1099-MISC which detailed the income you received from the other business. As a sole proprietor, that 1099-MISC is sent to both you and the Internal Revenue Service giving them an opportunity to match-up your income.

4. The typical “red flags” such as travel, entertainment, and automobile expense receive less attention on an S-Corporation return because the audit rate for S-Corporations is substantially lower that for individuals. [This is now in a change phase]

5. You can substantially reduce the amount of FICA taxes paid with an S-Corporation. A LLC requires that the owner pays FICA taxes on all of the net income. An S-Corporation is allowed to pay its shareholders a reasonable salary and the remainder of the net income can be taken by the shareholder free of FICA taxes. The savings to a small business owner of a profitable company can be thousands!!

6. It is easier for an owner of an S-Corporation to sell the business because there is no corporate level tax to be paid upon the sale similar to a C-Corporation.

To summarize, small business owners who are currently organized as an LLC or a Sole Proprietor can reduce their risk of a painful Internal Revenue Service audit and save a significant amount of taxes by switching to an S-Corporation.

• IRS Scrutiny of 1040’s– IRS to emphasize 1040 every year - In the past few years

IRS placed an emphasis on 1120 and 1120 S for audit. Now IRS has decided that they will look at 1040’s every year. This means that the most likely item to trigger an audit is Schedule C. Clients with a Schedule C, home office, and un-reimbursed employee expenses from Schedule A are guaranteed an audit and most likely a detailed rather than letter audit.

– Treasury Emphasis on Schedule C – The Schedule C return places the form 1040 for the taxpayer for computer check in other areas. A simple Schedule C may not be enough for an audit but it significantly increases the value of the return in IRS system. The IRS computer then checks the return for home office, auto expenses [make sure the taxpayer has mileage log], un-reimbursed employee expenses, etc. All your Schedule C clients should expect scrutiny.

• i. Red Flags – items the IRS computer will search if a Schedule C return is filed.

» Office Deduction» Depreciation» Rental Property» Auto Expenses » Schedule A

• 1. Un-reimbursed Employee Expenses» Medical Expenses» Charitable Contribution» Assets» Travel» Meals» Entertainment» Continuing Professional Education [CPE]

• ii. IRS Audit Techniques – The client letter will request that the taxpayer provide all their information to IRS for a tax year. This should come as an IDR [Information Document Request].

» Only provide the documents specifically requested» Send the material if it is a mail or letter request. If you have

Power of Attorney [POA] Form 2848 then you speak with the agent.

» Auditors are now in “fishing season” so watch for the hook.

– IRS is “unofficially” doing a project on un-reimbursed employee expenses – this means that if you file a Schedule C and have a Schedule A with un-reimbursed employee expenses IRS will place additional scrutiny on the return. This has caused problems already for individuals that are college professors, individuals working for other federal agencies, and preparers.

– Audit Guides– Audit Letters – If you or your client receives an audit

letter, read it carefully as see what it requests. Only provide the information requested. The IRS will ask you to provide all the material for a return and multiple years which are designed to cast a wide net or troll in the hope to find some information which would lead to an additional assessment of tax. IRS loves to speak with the client at the IRS office or the job site of the client in the hope of discovering “additional information.” No matter how well intentioned the client, they will inevitably provide more information than needed and increase the likelihood of added tax. IRS auditors are trained to ask questions to fluster and anger the client into divulging information which may mean added taxes. As the representative of the client taxpayer whatever the IRS says is business, not personal, and you may respond.

– IDR – Information Document Request Form 4564 Information Document Request [IDR] This is the form that will be sent to a client with the tax years in question and the particular documents requested. Read what IRS asks and only provide what is asked in the IDR. This will limit the scope of the audit. If the IRS wants other documents make them file an IDR for each document. This way you do not have to show up with a fishing hat at the IRS office because the auditor is trying to expand the search by casting a large net. The form will have canned paragraphs and segments citing the Internal Revenue Code why they would be asking for the documents.

– IRS will likely cite: Section 6001 – “Every person liable for any tax imposed by this title, or for the collection thereof, shall keep such records, render such statements, make such returns, and comply with such rules and regulations as the Secretary may from time to time prescribe. Whenever in the judgment of the Secretary it is necessary, he may require any person, by notice served upon such person or by regulations, to make such returns, render such statements, or keep such records, ass the Secretary deems sufficient to show whether or not such person is liable for tax under this title.”

– Section 7602 – “For the purpose of ascertaining the correctness of any return, making a return where none has been made, determining the liability at law or in equity of any transferee or fiduciary or any person in respect of any internal revenue tax, or collecting any such liability, the Secretary is authorized – To examine any books, papers, records, or other such data which may be relevant or material to such inquiry.

– Case history - In dealing with the case, you need to know what IRS has already done. This is the history of the case.

» Request from IRS - You have the right as a representative, to request a detailed history of what has been done on the case. You should be keeping a record of everything that happens on the case because you can be sure that the IRS is doing it.

» Keep a history of everything that takes place on the case. – a folder with a legal pad and all documents relating to the case is a start. Write down on the legal pad every time you contact the client, contact the IRS, mail or fax information. I find that the date and time to the minute shows a significant degree of professionalism which also lets IRS know that you are thorough. The more professional and thorough the fewer problems and better results from the audit.

» Send all correspondence with return receipt and signature. – Send information to IRS Certified with return receipt and mark the information in the case history. Faxes should be sent with a cover and acknowledgement that the fax was received.

POW

• Do not let your client speak directly with IRS - Think of a World War II POW camp where it is name, rank and serial number. You may provide the requested information; however, you do not need to give more than requested by the Form 4564

» Allows IRS to broaden the search» Client will inadvertently open new areas of

scrutiny

Areas of IRS Search

I. Officer compensation – we have already discussed remember line 7 of Form 1120S

II. YOUR HOME OFFICE

• Many people are afraid to take this deduction due to the rumors that it creates a “red flag” with the IRS. Actually, a home-office has the ability to create many other deductions along with it. As with anything that deals with the IRS, learning the rules and how you can use them for your advantage is the secret. The rules on deductibility of home-office expenses are can be very tight; understanding the rules can provide wonderful tax write-offs that pass IRS scrutiny. In 1999, the rules governing home-offices were revised and give the taxpayer much more flexibility.

• To deduct expenses related to the business use of part of your home, you must meet specific requirements. Even then, your deduction may be limited.

• This section describes the tests that you must meet to qualify for the deduction. To qualify to claim expenses for business use of your home, you must meet the following tests.– Your use of the business part of your home must be:

• • Exclusive,• • Regular,• • For your trade or business, and

– The business part of your home must be one of the following:

• • Your principal place of business,• • A place where you meet or deal with patients, clients,

or customers in the normal course of your trade or business,

– Or• • A separate structure (not attached to your home) you

use in connection with your trade or business.• That little item (2), your principle place of business,

opened the door to anyone who only has his or her own office in their home as a regular workplace.

It does not have to be a whole room; it can be part of a room. It doesn’t have to be just a room; it can also include closet space, garage space, carport or a parking pad for your primary business vehicle or tools (tractors, cement mixers, clown cars, drill presses...)

Requirements for Home Office Deduction• Under the present rules, pretty much everyone who operates a

business will have a legitimate claim to an office in the home. So, for the IRS, the odds of finding fault with this deduction on a tax return from 1999 onward decrease dramatically.

• This change does potentially open the home-office deduction to people who do their income-producing work outside of the home — such as plumbers, repairmen, contractors, therapists, computer technicians and other consultants — but who need to do their billing, scheduling and other paperwork or administrative/management tasks out of a home office.

• Examples of ExpensesCertain expenses are deductible whether or not you use

y our home for business. However, if you qualify to claim business use of the home expenses, you can use the business part of these expenses to figure your

business use of the home deduction. These expenses include the following.

– • Real estate taxes.– • Deductible mortgage interest.– • Casualty losses.

• Other expenses are deductible only if you use your home for business. You can use the business part of these expenses to figure your business use of the home deduction. These expenses generally include (but are not limited to) the following.– • Depreciation*– • Insurance.– • Rent - This can be a major tax break for those that

do not own a home. If you itemize and you are a renter, then you are one in only a handful of Americans that rent and file Schedule A. With no deduction on Schedule A (Itemized Deductions), renter can find a great tax break by having a home-based business.

III. AUTO EXPENSES: How to pay for your vehicle in five years!

• This is a very important deduction and can be one of your largest personal expenses. If you use your car for business, you can choose from two different methods to deduct business-use charges. The most common method is to deduct the amount per mile that the IRS allows in any given year for business travel. In 2008, it is 58.5 cents a mile. I often tell my clients to get one twenty dollar bill and then drive down the road throwing the $20 bill out the window every 34.2 miles. This will show you what you are giving away unless you learn how to record your business miles and take this deduction.

• Alternatively, you can itemize: take a depreciation deduction on the cost of your vehicle and add to that all the costs of running and maintaining your car (gas, oil, parking fees, repairs, insurance premiums, tolls, tires, licenses and registration fees).

• Once you begin taking the mileage method, you must stay with that method until you purchase a new vehicle.

The Junior Auditor say’s: The key here is to make sure that wherever you drive, you turn the mileage into business miles. As stated previously, you may deduct as business mileage the miles driven between two business locations or places of employment. Establishing your home office as your regular work place becomes critical to qualify for this great deduction.

You Must Keep Good Records!

The Junior Auditor say’s: Intent is crucial in receiving this deduction. If you go to COSTCO to purchase an item and end up doing business, then your intent does not allow a business mileage deduction. However, if your intent is to find people to do business with and end up purchasing an item at COSTCO, then you have a deduction. The purpose of this is not to find a way to cheat on your taxes. The purpose is to understand the mind-set of an entrepreneur and create tax deductions as you create wealth. You can create a tax deduction just about every time you get in the car!

ASSETS: Appreciate your assets but depreciate them for your business

Example: Juan purchases a new computer to keep track of his soaring sales. The computer is not part of Juan’s product inventory because it was bought to be used in his business not to be resold. Since it will last for more than one year Juan must depreciate it or expense it under Section 179.

Deducting Capital Expenses

There are two ways to deduct capital expenses.• You can depreciate them, deducting some of the

cost each year over the assets useful life. You may deduct most of the cost in one year using section 179 of Internal Revenue Code [IRC].

• Using Section 179 you can deduct up to $125,000 in long term assets purchased each year. Due to the size of the deduction and the time value of money most home businesses no longer need to depreciate long term assets. This HUGE change in the tax law can greatly benefit you! Discuss this and other asset depreciation needs with The Tax Insider.

Personal Property Converted to Business Use

• If you use property in your home office that was used previously for personal purposes, you cannot take a section 179 deduction for the property. You can depreciate it, however. The method of depreciation you use depends on when you first used the property for personal purposes.

• If you began using the property for personal purposes after 1986 and change it to business use in 2008, depreciate the property under MACRS.

• The basis for depreciation of property changed from personal to business use is the lesser of the following.

• 1. The adjusted basis of the property on the date of change.

• 2. The fair market value of the property on the date of change.

• If you began using the property for personal purposes after 1980 and before 1987 and change it to business use in 2008 you generally depreciate the property under the accelerated cost recovery system (ACRS). However, if the depreciation under ACRS system is greater in the first year than the depreciation under MACRS system (Modified Accelerated Cost Recovery System), then you must depreciate it under MACRS.

Bottom line: Running a business as an S-Corp is often a smart tax strategy. However, the tax rules for S corps can be tricky and there are potential traps for the unwary. Beyond that, the IRS knows some taxpayers have used S corps to evade taxes.

In any case, now is a good time to make sure your S-Corp is not over-exposed to adverse tax issues in the event of an IRS audit. You might want to consider conducting a “self-audit” to highlight any problems and take corrective actions before the IRS comes calling. Your tax adviser can help with that, and at the same time, assist you in collecting the maximum amount of tax savings allowed under the law.

Suggested Material• For more information about "Reasonable Salaries"

S Corporations and Reasonable Salary• More Tax Planning: U.S. Quick Tips • Suggested Reading• S Corporations ProfileS Corporations OverviewS

Corporation Information• Suggested Reading• Business TaxesIncome TaxesTaxes• Related Articles• Converting Property to an S-Corporation - S-Corps & Reasonable

Compensa... • Issues Regarding Compensation of Corporate Officers • Tax Implications in Choosing a Type of Business Organization • Salary and Compensation Trends for Forward Thinking

Organizations • Self-Employment & Payroll Taxes for S-Corporation Shareholders

CPE Credit

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