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Simplifying S Corporation Taxes
 Would End ‘Reasonable Compensation' Game

Tax News

The Treasury Department is looking to tax income earned by S corporation shareholders the same way as partners' income is taxed, an official said.

“There are lots of games being played with regards to reasonable compensation,” Benjamin Willis, an attorney-adviser in Treasury's Office of Tax Legislative Counsel,  said March 6 at the Federal Bar Association Tax Law Conference. “It is one of the most audited areas” in S corporations.

Partners pay the Self-Employment Contributions Act (SECA) tax on the entirety of their share of income. S corporation shareholders pay taxes only on an amount deemed “reasonable compensation.”

President Barack Obama's proposed budget for fiscal year 2016 outlines a plan to tax shareholders of professional services businesses the same way as partners.

Merging the standards for S corporations and partnerships would simplify the administrative burden to research and define reasonable compensation for different industries, Willis said.

“The same thresholds applicable to these look-through entities should be standardized,” Willis said. “We are looking for a way to do that and address the complexity concerns, but also ensure there is an equality that's reached with respect to ensuring that folks are taxed on their wages appropriately.”

Many partners would like to be taxed under reasonable compensation rules, because then only a portion of their income could be taxed, said Cornelia Schnyder, managing director at Andersen Tax LLC.

Some entities have opted for an S corporation status over a partnership to take advantage of the tax requirements, according to the 2016 proposed budget.

We “are looking for simplicity and they are looking to unify the rules that apply to both S corporations and partnerships,” Willis said. “It puts S corporations on the same playing field as partners and partnerships.”