Audits of S Corporations

The IRS has begun targeting small corporations, LLC’s and partnerships who have made the S Corporation election for tax filing purposes.  Briefly, the difference between filing as a “C Corp” and an “S Corp” is as follows.  A C Corporation files a tax return in which a profit or loss is shown, and if it shows a profit, the corporation pays the tax.

The S Corporation also files a tax return, but in that tax return, all profits or losses of the entity are passed through to the shareholders or members or partners, as the case may be.  This is done on a Form K-1, which the shareholder files with his personal tax return.  By definition, the corporate tax return shows a “0″ profit or loss, since it is passed through.  This can benefit the shareholder, but this type of filing is prone to error.  Remember that the “S Corporation” designation applies only to the way the taxes are filed and this election can be made by any legal entity.

Many preparers make mistakes in filing these returns for various reasons.  Some are due to the preparer and some are due to information given to the preparer by the company.  In fact the IRS just released a study that found that 71% of S corporations who used paid preparers were non-compliant due to mistakes that usually benefited the taxpayer-shareholder.  They also found that S corporations are one of the fastest growing business types in the country.  Common mistakes are (a) deduction of ineligible expenses, (b) miscalculation of shareholder basis in the assets of the business and (c) payment of inadequate wages to shareholder-employees.  You can read the full report at www.gao.gov/new.items/d10195.pdf.

I will discuss these mistakes more fully in my next blog.