- 35 -
income due to payroll taxes on reported compensation.[10]
This calls into question the appropriateness of an
undercompensation analysis in the years 1986 through 1993.
Firstly, for 2 of the 8 years Hakala refers to (1986 and
1988), petitioner was a C corporation, not an S corporation. It
is not clear whether these mistakes were merely “harmless error”
or whether this affected Hakala’s conclusions.
Secondly, if Hakala’s thesis is correct, that this
“incentive” affected petitioner’s actions during the C
corporation years, then it becomes relevant to determine whether
(and to what extent) it also affected the similar-sized
businesses that provided the underlying data for the RMA ratios.
10 In general, an S corporation shareholder is taxed on the
shareholder’s pro rata share of the corporation’s income,
regardless of whether the shareholder actually receives a
distribution. Sec. 1366(a)(1). Where the shareholder is also an
employee of the corporation, there is an incentive both for the
corporation and for the employee-shareholder to characterize a
payment to the employee-shareholder as a distribution rather than
as compensation because only payments for compensation are
subject to Federal employment taxes. See secs. 3111, 3301. In
such instances, the Commissioner may recharacterize a
distribution as compensation in order to reflect the true nature
of the payment. See Rev. Rul. 74-44, 1974-1 C.B. 287
(“dividends” paid to S corporation shareholders treated as
reasonable compensation for services rendered and subjected to
Federal employment taxes); see also Veterinary Surgical
Consultants, P.C. v. Commissioner, 117 T.C. 141, 145-146 (2001),
affd. sub nom. Yeagle Drywall Co. v. Commissioner, 54 Fed. Appx.
100 (3d Cir. 2002).
Although Hakala argued that petitioner may have practiced
tax gamesmanship in one or more of the years before 1995, the
record does not disclose that respondent made a determination on
this matter, nor can we tell from the record whether petitioner
did distort the situation.
Page: Previous 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 NextLast modified: May 25, 2011