Comment by technothrasher
3 days ago
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.
I know what a CPA is, but what is a TLA?
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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.