The better chance the IRS has of successful C corp audits on their side, the higher the chances of an IRS audit against your corporation. The complicated U.S. tax code increases the chance they select your company.
The Federal tax rules regarding C corporations ensure that income is subject to taxes twice. There is tax at the corporate level. Taxes are then leveed again when making distributions to shareholders.
The corporation can reinvest all profits into the business and not pay out dividends. This avoids double taxation, but their shareholders will eventually complain about the lack of profit from their investment.
This is just one of the things that make C corporations unique. Uniqueness can be a benefit, but it can also leave you open to scrutiny. If you are a C corporation wondering about your chances of having to undergo a corporate tax audit, keep reading for interesting information.
The Chances of an IRS Audit by Income
The IRS audit rate increases for C Corporations as profits increase:
- 1% audit rate for assets less than $10 million
- 2% audit rate for assets between $1 million to $5 million
- 9% audit rate for assets between $5 million and $10 million
- 2% audit rate for assets between $10 million and $50 million
The majority of business audits take place in the field. This means you or your tax professional meets with the auditor face-to-face at the place of business. When the IRS conducts an audit, they will likely require the production of a large amount of documentation within a short period of time, usually 30 days.
In 2014, 92% of all C corporation audits took place in the field. Also done in the field were 91% of S corporation audits and 67% of partnership audits.
Have You Been Audited? Get Expert Help From a Tax Attorney.
5 Things The IRS Reviews During a Corporate Audit
If you are wondering what happens in IRS C corp audits, the main purpose of the audit is to make sure the business is paying the proper amount of taxes. The size of the business and whether it files its own taxes or uses an outside account has no bearing on the decision to conduct an audit. The IRS audit follows a set of specific procedures.
When you are facing an IRS audit you need experienced tax attorneys who specialize in the audit process. They will make sure the audit is properly handled and will get things resolved quickly. Your attorney will keep track of deadlines to make sure nothing slips through the cracks.
1. Selling Stock
The C corporation is different from other businesses because it has the ability to raise money by issuing shares of stock to investors. There is no limit on the number of shareholders they can have.
Most private C corporation companies are not subject to the regulations of the Securities & Exchange Commission. At the time the stock is issued there are no tax implications to the business or shareholder because there is no immediate income.
When C corporations are issuing stock they need to make sure the transactions are legitimate and are not a way to hide what would otherwise be taxable income. The IRS will review stock sales to determine if the selling price of shares was at fair market value. If the sale was at a discount that was substantial, this indicates a purpose other than raising capital.
2. Employing Shareholders
A small corporation may have shareholders and their family members managing the company. The IRS realizes this provides the opportunity to hide nondeductible payments into deductible compensation.
To determine if this is taking place the IRS will review the salary of every employee. They look to determine if the services the employee provides are comparable to the salary they receive.
If an employee appears to be receiving excess compensation, the auditors will determine whether the salary is a way of reducing the tax rate on corporate earnings. It is also sometimes used as a way to make non-deductible political contributions.
3. Form 1120 Schedule M-1
A corporate tax return is prepared on Form 1120. In addition to scrutinizing the entire form, Schedule M-1, which is unique to corporations, will be of special interest.
Corporations tend to keep their books and records according to generally accepted accounting principles (GAAP). This means there is usually a difference between the net income on the books and the amount shown for tax purposes. Schedule M-1 reconciles book income or loss with the income or loss calculated under tax laws.
This makes it possible to report an incorrect amount of corporate tax. The IRS will review the details of the reconciliation. This ensures the business uses proper rules when making adjusting entries.
4. Bonuses Deducted as Expense
Corporations are able to deduct bonuses they pay employees on their taxes. However, there are some types of bonuses that do not meet the criteria as deductible expenses.
Cash Bonuses
Cash bonuses you pay to an employee are deductible as wages when paid as compensation for services, not as a gift. The employee must perform the services prior to receiving the bonus.
You must include these bonuses on the employee’s W-2 as income and the corporation must withhold income taxes. The company also needs to pay the employer portion of Medicare and Social Security taxes.
To be deductible the wages, including bonuses, must be reasonable in their entirety,
Property Bonuses
When an employee receives property bonuses, it is deductible like wages and must be listed on the employee W-2 form. The property bonus must meet IRS standards for wage and salary reasonableness.
The tricky part of this deduction is determining the value of the property. When you give an employee property, such as a vehicle, you need to use the property’s fair market value at the time of transfer. You cannot use the price the corporation paid at the time you acquired the item.
Achievement Awards and Gifts
Achievement award recognition has an annual deduction limit of $400 per employee. If the corporation has a qualified plan, meaning a written policy that outlines the procedures for payment of awards, the annual deduction per employee increases to $1,600.
If the corporation rewards employees with small gifts, such as movie tickets, holiday parties, etc. those expenses may be deducted in full as a regular business expense. These items are not employee compensation.
5. Reasonable Employee Compensation
If the IRS audit determines employee compensation is not reasonable, the portion they deem in excess will not be a deductible expense. What is reasonable for one employee may be unreasonable for another. The term “reasonable” is based on each employee’s individual circumstances.
One way to determine reasonableness is if the total wages and bonuses you give an employee would be offered as a compensation package by another corporation. Factors the IRS will review include:
- Duties performed
- Volume of business employee is responsible for
- Time commitments
- Skill set
- Complexity of work performed
- Bonuses and wages offered other employees
For example, a $100,000 bonus to a top executive may pass scrutiny. If you give that same $100,000 bonus to a janitor or secretary, the IRS may determine it unreasonable.
Avoid the IRS Corporate Tax Audit
When it comes to C Corp audits, the IRS watches for specific activities that may trigger an audit. To avoid standing out under an IRS microscope, avoid these activities:
- Filing forms 1096/1099 late
- Too much officer life insurance on the expenses—whole life insurance policies are an investment asset and listing it as an expense sends up IRS red flags
- Exorbitantly high expenses in areas of entertainment, meals, or automobiles
- Not properly moving retained earnings from the prior period to the current year
- Profit margins that are inconsistent with prior years
- Claiming 100% business use on a vehicle when the driver has no personal vehicle
- The corporate balance sheet doesn’t balance
- Giving money to officers as a loan rather than payroll—a huge red flag; corporations often do this to avoid paying payroll taxes and the officer avoids paying income tax
- Not paying or receiving interest on loans to officers—gives the appearance of moving money to hide it
- Shareholders who are employees receiving salaries that are unreasonably high—lowers corporation profits
- If you report negative profits several years in a row the IRS wonders how you are still in business
- The corporation has a retail business with inventory and every year ends with the business having zero inventory
Every corporation wants to lower the income on their books to lower their taxes. If steps taken are too drastic or aggressive they increase the chances of an IRS audit.
Even if you take all appropriate steps to avoid an audit, you may find yourself holding an IRS audit notice. Your first call needs to be to qualified tax attorneys who can answer your questions quickly. If you are receiving IRS threats make sure you contact a law firm that provides emergency assistance. Attorneys with experience in tax audits can help prevent levees from being placed on your bank accounts or other negative actions.
Don’t Be a Fraud Suspect
It may be hard to imagine, but fraud happens in every level of business. Who better understands the manipulation of money than someone in an accounting department? To keep your business away from the IRS audit process, you need to make sure your financial records are up-to-date and clean to avoid a claim of fraud.
IRS special agents follow strict procedures when initiating fraud investigations and recommending prosecution to the Department of Justice. Several IRS officials must agree that the investigation results are based on factual evidence of tax fraud or another financial crime before initiating prosecution.
The IRS Criminal Investigation Fiscal Year 2021 Annual Report released in November 2021 shows that more than 2,500 criminal investigations found more than $10 billion in financial crimes and tax fraud. The conviction rate on these charges was 90%.
The only federal law enforcement officers who have the authority to investigate violations of the U.S. tax code are IRS-CI (criminal investigation) agents. The corporate fraud program focuses on violators in private or public corporations and the senior executives of those organizations.
Fraudulent acts include fabricating, falsifying, or destroying company records. Those false records are used for creating financial reports and statements for investors and regulatory agencies. They also use them for completing tax returns.
Other areas of corporate fraud include fraudulent loans for personal expenses, payments and bonuses that are not approved, and executives receiving unauthorized compensation.
Notable Case Example 1: Tax Evasion and Conspiracy to Defraud Government
In August 2021 two sisters were sentenced in the United States District Court for the Middle District of Florida on a $25 million tax fraud scheme. The sisters created five tax preparation companies as a way to conceal their fraud. Some of those companies were opened using false names.
Between January 2012 to June 2016 the sisters submitted over 16,000 false tax returns resulting in their receipt of tax refunds in excess of $25 million.
Petra Gomez was convicted and received eight years in federal prison for tax evasion and conspiracy to defraud the government. Her sister, Jakeline Lumusco received a four-year sentence following a plea agreement for conspiracy to defraud the government.
In addition to their prison sentences, the sisters must pay $24,940,495 in restitution to the IRS, plus an additional $510,999 to the IRS for tax evasion.
Notable Case Example 2: Conspiring to Violate Labor-Management Relations Act
In March 2021 FCA US LLC a/k/a Fiat Chrysler Automobiles, in Auburn Hills, Michigan pleaded guilty to conspiracy to violate the Labor Management Relations Act (LMRA). The FCA was making illegal payments to officers of the UAW (United Auto Workers) union. Part of the plea agreement is the FCA’s obligation to pay $30 million in fines and be subject to federal oversight.
The FCA conspired with other organizations and people to violate the LMRA by making illegal payments totaling more than $3.5 million. Payments went to officers of the International Union, United Automobile, Aerospace, and Agricultural Implement Workers of America (UAW) from 2009 through 2016.
Senior officials received illegal payments in violation of federal labor laws. They also took part in a conspiracy to embezzle money from the UAW for their own personal benefits. Those found guilty or taking a plea in this conspiracy are too numerous to list, but include the following executives:
Vance Pearson—former Director of the United Auto Worker’s Region 5 and former member of the UAW’s International Executive Board
- 1 year in prison
- $250,000 in restitution to UAW
- Forfeiture of $122,258 for conspiring to embezzle UAW dues money for additional racketeering crimes
Gary Jones—former President of the International United Auto Workers Union
- 2 years in prison
- $550,000 in restitution to UAW
- $42,000 restitution to IRS
- Forfeiture of $151,377 plus $10,000 fine for conspiring to embezzle UAW funds and default the United States
Dennis Williams—former President of the International United Auto Workers Union
- 2 years in prison
- $132,000 in restitution
- $10,000 fine for conspiring to embezzle UAW funds
Edward “Nick” Robinson—former President of the United Auto Workers Midwest CAP and former Director of the UAW Labor and Employment Training Corporation
- 1 year in prison
- $342,000 in restitution
There are 11 other individuals charged with this criminal activity. Ten have received their sentences, one died prior to their sentencing hearing.
Get Help With or Avoiding IRS C Corp Audits
Even when you do everything by the rules, the chances of IRS C Corp audits do exist. If you find yourself holding an audit notice from the IRS your first step is to call (855) 900-1040 to enlist the services of our experienced corporate tax attorneys.
Our knowledgeable attorneys will walk you through the audit process, making sure a resolution is reached in a timely fashion and all deadlines are met. We can help you avoid levees and keep payments and penalties from spiraling out of control.
Contact us today to schedule an appointment so we can answer questions and discuss your tax-related case.
