Paying Yourself – What is Considered Reasonable Compensation by the IRS?

by Amanda Domitrowich

A corporation can deduct the compensation that it pays, but not its dividend payments. Thus, if funds are withdrawn as dividends, they’re taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is taxed only once, to the employee who receives it.

However, there’s a limit on how much money you can take out of the corporation in this way. The law says that compensation can be deducted only to the extent that it’s reasonable. Any unreasonable portion is nondeductible and, if paid to a shareholder, may be taxed as if it were a dividend. As a practical matter, IRS rarely raises the issue of unreasonable compensation unless the payments are made to someone “related” to the corporation, such as a shareholder or a member of a shareholder’s family.

How much compensation is “reasonable”? There’s no simple formula. IRS tries to determine the amount that similar companies would pay for comparable services under like circumstances. Factors that are taken into account include:

• the employee’s duties;
• the amount of time required to perform those duties;
• the employee’s ability and accomplishments;
• the complexities of the business;
• the gross and net income of the business;
• the employee’s compensation history; and
• the corporation’s salary policy for all its employees.

There are a number of concrete steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation. For example, you can:

• Use the minutes of the corporation’s board of directors to contemporaneously document the reasons for the amount of compensation paid. For example, if compensation is being increased in the current year to make up for earlier years in which it was too low, be sure that the minutes reflect this. (Ideally, the minutes for the earlier years should reflect that the compensation paid in those years was at a reduced rate.)
• Avoid paying compensation in direct proportion to the stock owned by the corporation’s shareholders. This looks too much like a disguised dividend and will probably be treated as such by IRS.
• Keep compensation in line with what similar businesses are paying their executives (and keep whatever evidence you can get of what others are paying—such as salary offers to your executives from comparable companies—to support what you pay if you’re later questioned).
• If the business is profitable, be sure to pay at least some dividends. This avoids giving the impression that the corporation is trying to pay out all of its profits as compensation.

As in most tax situations, planning ahead avoids problems later. Contact our office today to discuss this or any other aspect of your current or deferred compensation strategies.

Create Online Tax Accounts Now!

by Kassandra Cristobal

Have you created your online accounts with the Internal Revenue Service (IRS) and Franchise Tax Board (FTB) yet? We encourage ALL of our clients to create or update their online accounts with the IRS and relevant state tax agencies. With online accounts, taxpayers gain access to important tax information including balances due, payments made, tax records, and more.

In many cases, you can locate or request relevant information via your online account which will minimize or eliminate the need to sit on hold with tax agencies. Plus, account creation takes just a few minutes! Individual taxpayers have the ability to create both Federal IRS and California FTB accounts, however businesses are only able to create California FTB accounts at this time.

The following and more can be done via your online accounts:

Both IRS and FTB:

• View account balance, including taxes due from prior year returns
• Make electronic payments and create payment plans
• View tax payment history, including past estimated tax payments
• View Notices and Letters of correspondence
• View and authorize Power of Attorney (POA) for outside parties

IRS:

• View tax records relating to advance payments of the Child Tax Credit and Economic Impact Payments (EIPs)

FTB:

• View past copies of your California tax returns
• Send a secure message to an FTB representative with questions regarding your account
• Authorize Full Online Account Access for your tax professional representative(s)
• View tax payment history, including the new Pass-Through Entity (PTE) Elective Tax payment

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Federal IRS

Log-In Page: https://www.irs.gov/payments/your-online-account

The IRS has partnered with ID.me, an IRS-trusted technology provider, to provide identity verification for IRS applications. Individual taxpayers and tax professionals are required to verify with ID.me for a secure login.

Please note, existing IRS username and passwords no longer work as of Summer 2022. As such, we suggest creating an ID.me account and completing the identity verification process now.

How to sign-up:

Select “Sign in to your Online Account” and either create a new account or sign-in using a previous login.

If you have an existing ID.me account from a state government or federal agency, you can sign-in without verifying your identity again. If you’re a new user, you’ll have to create a new ID.me account.

To create your account, you will need:

• A valid email address.
• Your birthdate.
• Your Social Security Number (SSN).
• Your current mailing address.
• Your mobile phone number (must be a smart phone with internet and texting capabilities)
• Your ID (driver’s license, passport, or state ID)

Tips for creating your ID.me account:

• Make sure you have access to a computer, your smartphone, and your email. You’ll be asked to go between all 3 in order to verify your identity.
• You’ll need to use your smartphone to take a photo of your ID.
• You’ll need to use your smartphone or your computer’s webcam to take a computer-generated selfie photo.

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California FTB

Log-In Page: https://www.ftb.ca.gov/myftb/index.asp

Step-by-step Instructions: https://www.ftb.ca.gov/myftb/help/how-to-guides/individuals/register.pdf

How to sign-up:

You must have a recent California tax return on file in order to register for a MyFTB Individual account. If you filed a joint tax return, you must each register for a separate MyFTB Individual account.

To create your account, you will need:

• A valid email address.
• Your Social Security Number (SSN).
• Your current mailing address.
  • Important! If you moved since you filed your last tax return, call the FTB to update your mailing address before you register for a MyFTB account, (800) 852-5711.
• Information from a filed California tax return for one of the last five tax years.

After you create your account, you will receive a letter in the mail containing a Personal Identification Number (PIN). The PIN will be mailed via the United States Postal Service within 3 to 5 business days. Please allow 10 business days to receive the PIN. You have 21 days from the date you register to enter your PIN to activate your account.

This is a one-time use PIN is used to activate your MyFTB account. You will not need it again to login. You will need to enter this PIN online in order to activate and gain access to your account.

Please note: Individual taxpayers also have the option of activating their account via online “personal question” screening instead of the mailed PIN.

Recent Changes to the Employee Retention Tax Credit (ERTC)

by Marc Cappelloni

In case you missed it in our February tax newsletter article entitled IRS Turbocharges the Employee Retention Tax Credit…

Recent changes to the Employee Retention Tax Credit (ERTC) have the potential for a huge refundable payroll tax credit for your business!

New legislation passed now allows even recipients of PPP loans to take the credit retroactively for 2020 (previously not allowed) and has recently further extended the credit through December 31, 2021.

To be eligible for this credit, the business must either:

1. Have been fully or partially suspended due to orders from a governmental authority or
2. Suffer a significant decline in quarterly gross revenue as measured against 2019
3. 50% decline for 2020
4. 20% decline for 2021

Below is a summary of the updated payroll tax credit amounts potentially available to your business:

For 2020, there is a maximum credit of $5,000 per eligible employee. The 2020 credit is computed at a rate of 50% of qualified wages paid, up to $10,000 per eligible employee for the year. For Eligible Employers with less than 100 average full-time employees in 2019, the credit is available for all employees receiving wages in 2020.

For 2021, there is a maximum credit of $7,000 per eligible employee, per quarter. The 2021 credit is computed at a rate of 70% of qualified wages paid, up to $10,000 per eligible employee, per quarter. For Eligible Employers with less than 500 average full-time employees in 2019, the credit is available for all employees receiving wages in 2021. Don’t leave money on the table! Please contact us today and we will connect you with a payroll tax credit specialist referral who can review whether you qualify for the Employee Retention Tax Credit and determine the amount of payroll tax credit your business can claim.

California to Implement Wayfair “Economic Nexus” Thresholds starting April 1st, 2019

By: Kassandra Cristobal

Beginning on April 1^st of 2019, certain retailers located outside of California that are engaged in business in the state (but with no physical presence in the state) will be required to collect California state and district use tax if their sales of tangible personal property are comprised of either:

• $100,000 of sales into the state; or
• 200 separate sales transactions into the state

Retailers will be required to collect the taxes on any sales taking place on or after April 1^st and remit them to the California Department of Tax and Fee Administration (CDTFA) through their sales and use tax return.

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San Jose Business Tax Certificate – Recent Law Change

 

The City of San Jose has changed the ordinance covering owners of residential and nonresidential rental property located within the City limits. The new ordinance requires owners of one or more rental units to register with the City, obtain a Business Tax Certificate, and pay an annual fee.

The City extended the deadline to register and pay the required tax to December 15, 2017, to allow additional processing time for the increased persons that now are required to register. If the payment of the business tax is made after December 15, 2017, then interest and penalties will accrue retroactive to July 1, 2017.

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