Covering the Gaps in Your Tax Planning: S-Corps and Licensed Professionals

Any person who is self-employed is likely familiar with the burden of having to pay the full share of self-employment taxes which are normally split between an employer and an employee. Because this can be a significant drain on the taxpayer, one might choose to organize her business as an S-Corporation; this form allows the worker to split her earnings into wages which are subject to employment taxes, and shareholder distributions which are not. It is a very effective way to reduce tax liability, and as such the IRS is on the lookout for ways to undermine this structure and reassess the self-employment taxes that would be due if there were no S-Corporation.

A recent tax court case highlights a new prong of attack by the IRS in the war to collect: meaningful control by an S-Corporation over a professional employee. In brief, the IRS questioned whether a corporation (in this case an LLC) could possibly exercise meaningful control over an employee with a professional license who is accountable to some regulatory body. The argument is that if the corporation can’t meaningfully control the employee (because the license requires independent judgment), that all earnings belong to the employee, not the business, and are subject to self-employment taxes. The interesting part of the case is that while “meaningful control” is hard to define, the case was actually decided upon a few key facts and that is what professionals in S-corporations can mine to learn here:

  1. Get your business licensed with your regulatory body. By registering your business with or under your license you avoid the entire question of who is doing the controlling and who is getting paid for services.
  2. Write all contracts for services under the name of your business. Don’t give the IRS an advantage by ignoring the business you took the time to set up. Write all of your service contracts, leases, utility deposits and agreements under the name of your business.
  3. Create an employment agreement between yourself and the business. It may seem silly but you should do your best to define your relationship to your business and therefore who is in control. This is also a good opportunity to adopt an Accountable Plan for the reimbursement of business related expenses.

The IRS will continue to look for new ways to challenge taxpayers’ business planning to reduce their liability. If you pay attention and continue to shore up your plan, then you are much more likely to sustain your tax savings over the long term.

If you have any questions about your business structure, regulatory concerns, employment agreements or an accountable plan, contact an attorney at Nielsen Law Group for help. You can schedule your initial consultation by calling (480) 888-7111 or submitting a web request here.