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Domina Law Group pc llo Cautions Against Tax Abuse


The IRS is cracking down on abuses. And it is doing so appropriately. "We have seen, and now handling, cases for professional persons who and others who followed CPA advice, set up their businesses to avoid payroll taxes by using artificially low "incomes" and taking "profits" claiming they are not subject to payroll taxes," David Domina said.

Domina Law Group pc llo is currently engaged in several cases in which we are “prosecuting civil fraud actions against offending CPAs, and for other clients we are defending white collar criminal cases" arising from abusive advice given by tax-planners.

A common scheme targeted by the IRS for enforcement actions involves abusively low “payroll” and mischaracterized “profits” in S-Corporations and Limited Liability Companies. By claiming low payroll income and taking the balance of closely held company earnings as payroll, some tax preparers have advised client they can avoid payroll taxes. All salary is subject to a 2.9% Medicare tax and some is subject to a 12.4% Social Security, or FICA, tax. (The FICA income cap is now $106,800.)

Profits are not subject to these payroll taxes. By reporting low pay taxpayers do not save any income taxes, but they do avoid -- at least they think they avoid -- thousands of dollars each year in the Medicare and FICA payroll taxes. The IRS is cracking down on this abusive practice.

A Wall Street Journal article published January 31, 2011 recounts the abuses of a Des Moines IA CPA who thought he could cheat with "profit" instead of payroll income in his own practice. A recent case won by the IRS against David Watson, a CPA in West Des Moines, Iowa in US District Court makes the point. It condemns the too common tax-cutting maneuver of mischaracterizing as "profit" what is really payroll income.

David E. Watson P.C. v. U.S., 4:2008cv00442, US Dist Ct, S D IA, revolved around Mr. Watson's low pay as the sole owner and shareholder of his own S-Corporation. Such companies, often called "Sub-Ss" after the subchapter of the tax code governing them, are popular choices for doing business. Unlike C corporations, Sub-Ss have no more than 100 shareholders, and they pass profits to owners without an extra layer of tax. The Wall Street Journal estimates there are about4 million Sub-Ss in the U.S. today. Many recently popular LLCs are used, and abused from a tax standpoint, in the same was as S-Corps.
Ruling for the IRS, the federal district court in Des Moines found that Watson's CPA firm made profit distributions of $203,651 and $175,470 to Mr. Watson through his Sub-S for 2002 and 2003, respectively, the years in question. Mr. Watson, who had a graduate degree in tax and 20 years' experience, received only $24,000 of salary for each of those years, far less than the $40,000 a year earned by recent graduates in accounting with no experience. The IRS objected because, unlike profit distributions, salary is subject to a 2.9% Medicare tax and often is subject to a 12.4%, or FICA, tax.

By reporting low pay Mr. Watson didn't save any income taxes, but he thought he saved nearly $20,000 in payroll taxes for the two years. The IRS pegged Mr. Watson's true pay at $91,044 for each year. The Court agreed. It ordered the taxes, with substantial penalties and interest paid.

More tax enforcement in this area can be expected. Domina Law Group pc llo's practice includes handling matters involving taxation- but only once they get to the litigation level. The firm does not provide tax planning or tax compliance services.

David A Domina

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