Everything Under The Sun: Recent Court Ruling Signals Auditing Changes

Thursday, February 25, 2016

Recent Court Ruling Signals Auditing Changes

The 2015 interns who spent time at SC&H Group.

It's still a little early yet, but quite a few individuals are thinking about income tax, preparing the forms, or looking for companies that can help them with this task. SC&H GROUP, located in Sparks, MD, does this important task, and more, for the businesses they serve.

Recently, members of the Tax Services team noted a court decision that would have an "impact on compensation deductions for professional services corporations." The ruling was entitled T.C. memo 2016-20, involved suspected unreasonable compensation. In effect, the decision made the professional services corporation responsible for the negligence penalty.

In other words, the court held that some of what was classified as salary to its shareholding attorneys was, instead, a dividend, and not pay for services. Treating this payment as compensation led to this firm underpaying its owed income tax.

In making this ruling, the Court disallowed 15 percent of the firm's year-end bonuses, assessed the regular corporate tax on these monies, and assessed a 20 percent penalty for the resulting underpayment of taxes. The focus was more on the penalty and not the disallowing of the compensation deductions. This firm hadn't requested an opinion from their auditors as to whether these bonuses were actually deductible.

What were the reasons for these audit adjustments, leading to the penalty?

*This firm had been ZEROING OUT their books, or treating their accounts as temporary, and resetting the starting amount for a new year at zero. This practice was documented in their board's minutes.

*The firm had been viewed as failing the INDEPENDENT INVESTOR TEST. In other words, a reasonable investor would not have been happy with ROI, and would not be happy with compensation of key employees.

*The IRS and the Court didn't consider the growth in fair market value of the firm. They focused on the growth, or its lack, of retained income or income on the books during the period of the audit.

*The firm had never paid a dividend or return to its shareholders.

Technology is a go for the SC&H Group radio show.

The ruling indicated an increased focus on deductions for compensation by the IRS.So, for both companies and auditors, it pays to devote more attention to these issues, both through planning and documentation. It can save a lot of heartache later.