Comment by jjeaff
21 hours ago
I can understand why they might do this. Many people who own a small business underpay themselves significantly and use the extra funds on the business to build up assets. This defers taxes and allows the funds to be reinvested without tax. They might even take out loans on those business assets. The same way the wealthy will pay themselves a tiny salary and just live off the asset value of their stock. Someone who owns their own business could also easily drop their salary significantly for the year prior to applying to college.
As an owner of a small family business, I have to pay close attention to making sure my salary and that of my other family members involved is "generally commensurate with our duties" or the IRS will be up my backside pretty quick. I obviously try to minimize it as much as possible, but if you drop it to something insignificant and the IRS notices, they'll adjust your income and expenses reported to reflect your non-compliance with tax code.
My understanding is that the IRS attitude toward this depends on the exact tax status of your small business. The approach you describe reflects an S corporation, which is nowhere near always the right choice for every small business that sends their children to MIT: as one counterexample, if the parents' business is in NYC, the city's General Corporation Tax (which applies to S corporations) is often more punishing than its Unincorporated Business Tax, and therefore many NYC small businesses organize as LLCs not taxed as a corporation if they even choose to create a separate legal entity at all.
For every type of business entity other than an S corp or an LLC electing to be taxed as one, the IRS either doesn't care about any notion of reasonable salary or - in the case of a C corp or an LLC electing to be taxed as one - actually wants it to be as low as possible (whereas the owner wants to maximize it).
From what I've observed (worked at a few small businesses before I got an office IT job, and even then...) it's about figuring out enough 'fringe benefits' and/or 'explanations' that are plausible with your CPA. e.x. how many profitable company car buy/leases can you do, a good explanation of why you are saving that money as a small or privately owned company (i.e. saving for expansion via acquisition/etc, but you have to follow through and then sell the results ASAP)
You can't have it be 'insignificant' salary but you can do plenty of fringe benefits or long term profiteering via acquisition as mentioned.
I will say, ironically, the small business owners like that were great to work for, although they were paranoid, they were often generous to employees.
OTOH, at the computer shop there was a standing rule that if the CPA brought his computer in it was 100% priority and we treated him better than the one org that was 10-30% (depending on year) of our entire gross income...
EDIT: To be clear, it's complicated, https://news.ycombinator.com/item?id=42199534 is a good explanation of where I sit overall.
CPA=Certified Public Accountant, the individual or company often hired by a small business to prepare their taxes.
CPA is not a great TLA as isn't global.
2 replies →
Are you saying that the IRS will literally officially modify your recorded / reported income and expenses to be different from what you reported, at their discretion, even if based on what they think are plausible reasons?
That still seems like heavy handed overreach to me. Should they not instead contact you for clarifications about the ambiguity?
Well, they'll express their disagreement in the form of a letter and then calculate what they think you should pay and how far behind you are on the usual withholdings as a result, along with penalties.
This is required to make some people honest who would otherwise report $1 income every time. They have to work a bit harder to optimize the tax.
> the IRS will be up my backside pretty quick
How many times were you audited before learning this valuable lesson?
Will they actually though?
You hear a lot of anecdotes both ways and it is quite hard to get a good picture of the real situation.
One hypothesis for why you see both anecdotes is that the IRS is extremely good at filtering out these cases… when they bother to look into it. A lot probably get by without ever being audited, but the small percentage that do regret it.
Keep a weather eye out with that line of scepticism. One of the opinions down that path is that MIT should adjust its admission procedures to filter out the children of honest businesspersons.
As a former owner of a small business I can tell you that what my accountant told me about that is that as long as the salary is over the Social Security max, (which is about $160K) the IRS doesn't really care.
> This defers taxes and allows the funds to be reinvested without tax.
All business funds are re-invested without tax, this is actually a good thing. Also for the majority of business owners taking a loan against your assets to pay yourself is a terrible idea, yes it may defer taxation but that tax will still come due and now you have to pay interest.
> Someone who owns their own business could also easily drop their salary significantly for the year prior to applying to college.
This could be a problem but i think the amount of difference this would make would be negligible - most people don't plan like this. You could also emancipate your 17 year old or have them live independently for a period of time (my friend actually deferred his entry and worked for a year in order to get a full ride)
> most people don’t plan like this.
This is a pretty naive take. It is a $85k per year cost. If you can shift some money around and avoid $85k per year, you would absolutely do that.
> you could also emancipate your 17 year old.
This is complicated. Emancipation is not a “sign a form” kind of thing. The kid would have to be living completely independently (no support from the parents) and would have to convince a judge that they need to have rights and responsibilities otherwise given to adults. “Because the parents don’t want to pay for school” isn’t really a valid reason.
I do appreciate how nonchalantly emancipating the 17 year old was suggested tho. Too funny. Two Americas?
Marriage triggers automatic emancipation. Just sayin'.
> All business funds are re-invested without tax, this is actually a good thing.
Paying tax and investing in your kid is also a good thing. Putting your income into the S&P 500 is also a good thing, but being wealthy enough to do so should exempt your children from this subsidy
I remember CEOs having a salary of $1...
Usually plus stock grants though, which are taxed as income.
>The same way the wealthy will pay themselves a tiny salary and just live off the asset value of their stock.
When you say them living off the asset value of their stock, you mean the dividends from the stock?
usually it's done by taking out a succession of loans, with the stock as collateral. that way the actual sale of stock is deferred until death
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