3 Reasons S Corps May Raise Tax Audit Red Flags.
Conventional wisdom is that S Corps are less NOT more likely to be audited, but there are situations, where conventional wisdom may, under certain circumstances be wrong.
Tax reporting mismatch.S Corps generally require unanimous consent forms, annual filing of Form 1120S, issuance of K 1s, W 2s for employees(including shareholder employees), and subsequent filings of Forms 1040 by its shareholders and/or employees. The law of averages, says there may be a higher chance of a tax filing mismatch, which could possibly lead to a tax audit.
Not paying enough compensation to employees.One of the benefits of S Corp tax election, is its ability to potentially lower self employment taxes. However, failing to pay a salary high enough, that could be construed as reasonable compensation by the IRS, could trigger IRS scrutiny, and the possible accompanying knock on the door by a tax auditor.
Paying too much compensation to employees.Unlike the previous reason, paying too much compensation to shareholder employees, that drives them to the point of illiquidity, as well as, causing S Corps to sell assets and/or accumulate business debt to pay out shareholder compensation, could also be a trigger for a tax audit.