Dental S-Corp Unreasonable Compensation Issue

I am going to do SEP IRA for 2008 after I bonus myself and my wife (an employee) in my s corp. I want to max out at the 46k for me and my wife so I will bonus both of us so we will make a total of 360k and do a SEP for 90k. I have no other employees that are eligible acc to my advisor. Here is the part I am leery about. My advisor says to do the SEP with Oppenheimer funds he recommends class a shares at an initial entrance fee of 4-5% but ongoing fees of around 1%. He says this is better than class b or c shares because I have a long time before these funds are eligible for withdrawal. What do think about this scenario?


My question is what does your wife do to earn $180k/year?

She is a FT employee and does A to Z, why does it matter? My accountant says it is fine because we will be paying taxes on that bonus. Do you have input on my concern about the SEP and the fees?

Sorry, no advice on the fees, that’s an investment issue that your investment adviser needs to counsel you on.

On the salary and why it matters? There are still issues with S-corps and unreasonable compensation to owners or those related to owners. While I agree that even if the IRS had an issue with $180k being unreasonable for her duties you’d likely pay less Medicare tax if you let that income flow through as S-Corp division (maybe $3,000 less??). However, my concern would be what if they did reduce her compensation to a more reasonable level, how would that impact the SEP contribution you made on her behalf? They may disallow that deduction AND you would have overfunded the plan which comes with excise taxes (for overfunding) and between those taxes and the loss of deduction for the excess contribution you’re exposing your self to a real bad situation IF you get audited and IF they take that position. It’s Russian roulette.

Just my opinion mind you, maybe you’ll be lucky and it’ll never be an issue.

Good luck.

Spoke to my accountant. He says S corps do not have that distinction anymore, C corps do. He said he has not see in a long time unreasonable compensation as the issue with an S Corp, he says under compensating is an issue because of avoiding the 15% SS tax and bonusing out a large amount of money that avoids SS tax.

Hmmm, it’s pretty common knowledge that the IRS has been targeting S-Corps for unreasonable compensation and you’re right, usually under compensating the owner to avoid the SS and Medicare taxes. However, whenever they audit the S-Corp for anything they look at everything and over compensating a related party by any entity to increase the retirement benefit for the owners and their family is a HUGE no-no. I’ve had 3 S-Corp audits in the past 3 years, all looking for unreasonable compensation and I can’t remember the last C-Corp audit I’ve had for any reason.

So I am going to keep my wife’s salary where it is and bonus out to me so I can contribute the max to the SEP of 46k. The remaining profit will pass through and I will pay income tax on it, and no SS tax. If I bonused my wife, I could owe a ton of SS tax, like you stated-however a lot more than 3k!

You’re right, if you bonused out your wife in excess of say $60k you’d have both SS and Medicare taxes of nearly $8k on $100k of her w-2 compared to $100k of your S-Corp profit.

Also, on something you said above, I don’t think SEP’s allow 100% contribution of w-2, deferral plans allow that, like 401k’s or SIMPLE’s, SEP’s maximum contribution is 25% of w-2 as I recall.

Interesting! Should I consider a C Corp then? I will sure be looking into this.

No, you’re doing the right thing with the S-Corp. There may be other ways to maximize retirement plan contributions for you and your spouse while minimizing the contributions to others with different plans (other than a SEP) so take that second opinion consult and ask what you can do to achieve your desired results. There are a lot of variables and the results might not be great, at least you’d have a pension professional providing the analysis, not an insurance professional.

So to recap, I bonused myself to allow max SEP contribution, but left my wife at original W-2 amount. I will do a sep and then put 25% of her w-2 wages into the sep. I accelerated some expenses (I know more taxes next year with Obama, but I was dealing with here and now and an 85k tax burden(200k+ profit) so I wanted to reduce it. I will still end up with at least 100k profit and just pay the taxes on it. This was the first year (3rd year in business) with that size profit so I was over thinking it-although I should have bought the periolase!

Is sect 179 gone in 09, and do you need to purchase by 12/31/08 to utilize?

Sec. 179 is still alive and well in 2009. For equipment to be eligible in 2008 it should have been purchased AND placed in service by 12/31/08.

This post first appeared on DentalTown.

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