For its report, TIGTA analyzed all the S corporation returns received by the IRS between 2016 and 2018, looking for returns where the profits exceeded $100,000, there was a single shareholder, and no officer’s compensation was claimed. It found the IRS didn’t select 266,095 of such returns for a field examination. The analysis found that single-shareholder owners made profits of $108 billion and took $69 billion in the form of a distribution, without reporting they received officer’s compensation for which they would have needed to pay Social Security and Medicare taxes. TIGTA estimated 266,095 tax returns may not have reported nearly $25 billion in compensation, allowing business owners to avoid paying approximately $3.3 billion in FICA taxes.
Another issue is the involvement of nonresident aliens as business owners. TIGTA identified 151 S corporations with nonresident alien shareholders, but pointed out that S corporations are not allowed to have nonresident aliens as shareholders. “If the IRS had identified these 151 S corporations and their 424 returns, it may have converted them to C corporations and assessed $5 million in corporate income taxes,” said the report.
IRS officials agreed with two of the five recommendations in TIGTA’s report, agreeing to issue letters to the 151 S corporations with nonresident alien shareholders, asking them to review their eligibility status and analyze the population after a year. But the IRS didn’t agree with the other three recommendations to: evaluate the risk of noncompliance with officer’s compensation and update the IRS examination plan; evaluate the benefits of using thresholds and criteria in classification guidance; or use compliance results from established work streams to better inform decision-making.
“We believe our existing policies and procedures properly address compliance risk regarding officers’ compensation,” wrote De Lon Harris, commissioner of the IRS’s Small Business/Self-Employed Examination unit, in response to the report. He noted that the IRS relies on a highly trained workforce to exercise their professional judgment to determine which issues in an audit will be examined. He also pointed out that due to the COVID-19 pandemic, TIGTA was unable to review the complete case files and instead needed to work from a database that indicates how often an examiner formally pursues a particular line item on a return but doesn’t reflect how often the examiner evaluates and determines an issue was reported correctly.
Another issue is the involvement of nonresident aliens as business owners. TIGTA identified 151 S corporations with nonresident alien shareholders, but pointed out that S corporations are not allowed to have nonresident aliens as shareholders. “If the IRS had identified these 151 S corporations and their 424 returns, it may have converted them to C corporations and assessed $5 million in corporate income taxes,” said the report.
IRS officials agreed with two of the five recommendations in TIGTA’s report, agreeing to issue letters to the 151 S corporations with nonresident alien shareholders, asking them to review their eligibility status and analyze the population after a year. But the IRS didn’t agree with the other three recommendations to: evaluate the risk of noncompliance with officer’s compensation and update the IRS examination plan; evaluate the benefits of using thresholds and criteria in classification guidance; or use compliance results from established work streams to better inform decision-making.
“We believe our existing policies and procedures properly address compliance risk regarding officers’ compensation,” wrote De Lon Harris, commissioner of the IRS’s Small Business/Self-Employed Examination unit, in response to the report. He noted that the IRS relies on a highly trained workforce to exercise their professional judgment to determine which issues in an audit will be examined. He also pointed out that due to the COVID-19 pandemic, TIGTA was unable to review the complete case files and instead needed to work from a database that indicates how often an examiner formally pursues a particular line item on a return but doesn’t reflect how often the examiner evaluates and determines an issue was reported correctly.