FL DOR RT AUDITS - WAGE RECLASSIFICATION IS COMMING

FL DOR Reemployment Tax Audits – Prepare for Wage Reclassification

As you may or may not have noticed, the Florida Department of Revenue (FDOR) has increased its reemployment tax (RT) audit efforts. Besides specific RT audits, FDOR auditors conducting sales and use tax (SUT) audits have been providing questionnaires to taxpayers which shortcut the RT audit process and essentially ask for the same information in an abbreviated format. Despite the abbreviated nature, the FDOR most certainly passes this information on to the IRS. Along these same lines, the FDOR has issued a recent Tax Information Publication, TIP #1573B-01 (TIP), addressing reemployment tax gross wages to be reported.

The TIP starts out by noting that shareholders who are employees of an S corporation or a limited liability company (LLC) who elected to be treated as an S corp. for federal income tax purposes may receive both wages and distributions. The TIP notes the S corp. might "misclassify" a majority of the amount provided to a shareholder/officer in order to reduce employment taxes via some or all of the following methods rather than reporting any amounts above as wages:

  • distributions of cash or property;
  • draws as a business expense;
  • business expenses for payments of personal expenses of the shareholder-employee;
  • business expenses for use of business assets (although the shareholder-employee used some of the business assets for personal use);
  • amounts paid to an independent contractor; or as
  • a loan to the shareholder.

The TIP provides the amount of wages reported as paid to a shareholder-employee must be reasonable for the services being performed or the IRS (or FDOR) may reclassify any amounts listed above as wages. Internal Revenue Code (IRC) sections 3121(a) and 3306(b) generally define "wages" as all remuneration for employment. Citing sections from the Code of Federal Regulations, the TIP indicates the form of payment is immaterial. The TIP notes the IRC term "employee" includes an officer of an S corp. The TIP does note that the CFR provides an exception for officers who do not provide any services or provide only minor services and who neither receive nor are entitles to receive remuneration.

To support this TIP, it then cites a services of court decisions that held that the IRS has the authority and appropriately reclassified S corp. reported distributions as wages when shareholder-employee reported wages were considered unreasonably low. Included in this list is a Florida Administrative Code (FAC) rule addressing when wages are considered paid.

In addressing the determination of an amount being considered unreasonable compensation, the TIP indicates "an amount of zero is unreasonable and a wage amount below minimum wage for the hours worked is unreasonable." The TIP then cites to IRS fact sheet FS-2008-25 Wage Compensation for S Corporation Officers (available at http://irs.gov/uac/Wage-Compensation-for-S-Corporation-Officers). The fact sheet quotes the instructions to Form 1120S that "[d]istributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation." The fact sheet notes there are no specific guidelines for reasonable compensation in the Code or Regulations and that courts have ruled using determinations based on the facts and circumstances of each case.

The fact sheet provides the following factors:

  • training and experience;
  • duties and responsibilities;
  • time and effort devoted to the business;
  • dividend history;
  • payments to non-shareholder employees;
  • timing and manner of paying bonuses to key people;
  • what comparable businesses pay for similar services;
  • compensation agreements; and
  • use of a formula to determine compensation.

Additional guidance is available at http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/S-Corporation-Compensation-and-Medical-Insurance-Issues.

The TIP also addresses a list of final orders issued to S corps. or LLCs treated as S corps. for federal tax purposes by the Department of Economic Opportunity (DEO) where a Special Deputy ruled the Department reclassified as wages amounts originally classified as dividends or otherwise similar to the list above. The listed cases included the following reclassifications:

  • dividends reclassified as wages;
  • "draws", K-1 income, and an expense were reclassified as wages;
  • "draws" reclassified as wages where no wages were reported to the sole shareholder/officer;
  • distributions reclassified as wages for shareholder/officer who provided services for the corporation; and
  • K-1 ordinary income reclassified as wages for shareholder/officer who provided services for the corporation.

(cases available at http://www.floridajobs.org/office-directory/division-of-workforce-services/reemployment-assistance-programs/reemployment-assistance-tax-liability-rate-and-reimbursement-final-orders)

The TIP then concludes that "[t]herefore, if the Department determines that the amount of gross wages reported on a RT-6 report is not reasonable compensation for the services provided, but the shareholder-employee received other amounts misclassified as dividends, draws, payment of personal expenses, loans to shareholders, etc., the Department may correct the misclassification of amounts to wages so that the wage amount represents reasonable compensation."

The TIP finishes by noting that in addition to the IRS guidelines already noted above to arrive at the amount of reasonable compensation for the shareholder-employee, the FDOR may review:

  • State Occupational Employment and Wage Estimates by the Bureau of Labor Statistics, U.S. Department of Labor;
  • Florida Occupational Employment and Wages by DEO;
  • classified ads in websites online;
  • classified ads in newspapers and in industry journals; and
  • any other available resources,

to estimate what amount of wages would be considered "reasonable compensation."

RT tax is due only on the first $7K of wages each year ($8K for 2012-2014) but underreported wages potentially impacts a shareholder-employee's possible reemployment benefits, understates RT taxes if below the wage base, and may reduce shareholder-employee deductible pension contributions (as noted in the TIP). But, this TIP should be noted for its far-reaching potential. The TIP's cite to the sources the FDOR "may" review to arrive at the reasonable compensation provides items which offer a broad base of "authority" that can allow it almost any base to reclassify amounts as wages.

As noted above, the RT wage base is not significantly high meaning that the dollars might not be significant in many dollars (even possibly including Federal penalties and interest). But, any FDOR reclassification will undue any tax planning you and your client might have undertaken which could extend to other more significant arenas that look at or are based on taxable wages.

We exclusively handle state tax controversies which include RT matters. We have handled these types of matters with local service centers all over the state. Please consider that if you have any questions regarding RT issues, including potential wage reclassification, when you face this type of issue with your client. Our free initial consultation will allow you the chance to help identify the issues involved and determine if additional assistance is needed.

I hope that you don't ever need that type of assistance for your client. But, in too many instances, the FDOR doesn't give you a choice.

Matthew Parker Attorney; Florida Sales Tax Attorney; Florida Sales Tax Audit; Tampa Sales Tax Attorney; Tampa Sales Tax Audit; Naples Sales Tax Attorney; Naples Sales Tax AuditAbout the author: Mr. Parker is a sales and use tax attorney and an associate in the law firm the Law Offices of Moffa, Sutton, & Donnini, P.A., based in the firm's Tampa office. Mr. Parker's practice includes state tax audits and controversies involving sales and use tax and all other state taxes including communication service tax, cigarette & tobacco tax, motor fuel tax, and Native American taxation. Mr. Parker received his law degree and L.L.M. in Taxation from the University of Florida. To learn more about Mr. Parker, please visit his firm bio.

ADDITIONAL RESOURCES

FL TAX AUDITS – TAXPAYER BILL OF RIGHTS PROTECTS NO RIGHTS, published May 5, 2015, by Matthew Parker, Esq.

WHEN SALES TAX AUDITORS MAY NOT PICK AND CHOOSE RECORDS TO USE, published April 19, 2015, by Joseph C Moffa, CPA, Esq.

FL DOR Sales Tax Audits – Beware the Electronic Records Requests, published December 12, 2014, by Matthew Parker, Esq.

FL DOR – THE MAGIC BEHIND THE CURTAIN, published November 10, 2014, by James Sutton, CPA, Esq.

TAXPAYER FORCED TO SIGN AWAY RIGHTS TO REMIT TAX?, published September 2, 2013, by James Sutton, CPA, Esq.

CRIPPLING PENALTIES UNDER FLORIDA SALES AND USE TAX LAW, published July 19, 2012, by James Sutton, CPA, Esq.


Categories: