Owner Builder Experience

owner builder experienceIn October of 2010 I wrote an article discussing owner builder experience.

In that article I stated that owner builder experience was a red flag, so to speak.

Well that was then, this is now. With the current processing systems in place at the Contractors State License Board (CSLB), ALL experience, including owner builder experience is good experience.

If you have building experience on property that you own, and you need that experience to build your portfolio that will be submitted with your application, by all means, submit that owner builder experience.

The CSLB will ask you for documentation to back it up, so be prepared to show cancelled checks, copies of receipts for materials purchased, copies of all permits, etc.

You will also need to complete the project sheet that is contained within the CSLB application. Things to be aware of on that project sheet? Do not list that most or all of the work was done by contractors or sub-contractors. The CSLB will only give you credit for the experience that you did yourself. If the project sheet makes it appear that you did some, or little-to-none of the work, they will credit you with very much experience time.

Do they accept supervisory experience? Yes they do, most owner builders are non-journeyman level people and therefore don’t have the skills to have the title of supervisor. So stating that you supervised the owner builder project will most likely not be credited in your favor.

The amount of experience time the CSLB will grant for owner builder experience hasn’t changed. If you submit a project that took you one year, they will most likely grant you 4-6 months credit. That’s because they calculate what it would take a licensed contractor to complete the same project.

If you have experience to submit that was obtained as an employee, and you want to also submit your owner builder experience, you will need to submit a work experience form for each time period and for each separate owner building project.

So owner builder experience isn’t the red flag that it used to be. Now it’s an additional way of proving your experience to the CSLB. Good luck.

Happy Thanksgiving

Happy Thanksgiving to all of my readers. I appreciate your support, kind words, feedback and questions.

Happy Thanksgiving

I hope you have a wonderful holiday with family, friends, food, and football!

C-01 Contractors License Proposed Language

C-01 Contractors License Proposed LanguageThere was a stakeholder meeting at the Contractors State License Board headquarters office today that discussed the C-01 Contractors License Proposed Language.

At this meeting they outlined the proposed language for the new classification. It states:

“Adopt Section 832.01

Non-Structural Remodel and Repair Contractor

(a) A non-structural remodel and repair contractor remodels and repairs existing structures built for the support, shelter, and enclosure of persons, animals, chattels, or movable property of any kind, requiring the use of at least two unrelated building trades or crafts, except as excluded in this section.

(b) This section does not apply to any work or operation on one undertaking or project by one or more contracts, the aggregate contract price which for labor, materials, and all other items is more than $15,000.

(c) This classification shall not include the following:

  (1) altering, adding, or moving any load-bearing portions of the existing structure, including footings, foundations, and weight-bearing member;

  (2) Work requiring specialized engineering knowledge and skill as set forth in Business and Professions Code Section 7056; and

  (3) Work performed pursuant to a C-11 Elevator (Section 832.11), C-16 Fire Protection (Section 832.16), C-21 Building Moving/Demolition (Section 832.21), C-22 Asbestos Abatement (Section 832.22), C-31 Construction Zone Traffic Control (Section 832.31), C-32 Parking and Highway Improvement, C-34 Pipeline (Section 832.34), C-42 Sanitation System (Section 832.42), C-51 Structural Steel (Section 832.51), and C-57 Well Drilling (Section 832.57) classifications.

(d) An examination waiver for this classification as a closely related classification pursuant to Business and Professions Code Section 7065.3 shall be considered only for licensees who hold the B-General Building classification pursuant to Section 7057 of the code.

(e) The C-1 Non-Structural Remodel and Repair classification shall be available upon development of a trade examination.”

There was talk at the meeting that the maximum contract limit of $15,000 should be raised. Potentially to match the Utah license classification that the C-1 emulates. I believe the current limit was set to match the upcoming license bond increase which will be $15,000 at the first of the year. And it seems they’ve dropped the 3-story limit that was in place in previous wording of the legislation.

Bottom line, this should have a huge beneficial impact on the construction industry. Stay tuned for more information.

Do I have to submit an experience outline?

CSLB ExperienceI received an email today from a reader who was looking for an answer to this question:

Do I have to submit an experience outline with my application if I held the same classification over five years ago? The email stated:

Dear Mr. Cocciante:

Your Blog is a wonderful resource and I am happy I discovered it. I have a question I hope you can answer. Here is the scenario: Contractor fails to renew license, license expires, five years pass. Contractor must now apply for new a.k.a. Original License. Does Contractor need to complete and have Certification of Experience form signed? Per Bus. & Prof. Code 825(b) applicant “may compute experience without regard to the ten-year limitation.” So, essentially, Contractor may use the exact work experience used to obtain original license, and given that Contractor held license, clearly he has met the four-year minimum requirement … which leads me to the question of does Contractor need to include a Certification of Work Experience form?

I have read conflicting answers in another blog. One time they said the form was not required, another time they said it was. When I called the CSLB, a tech told me all Contractor needs to do is write “See License No. XXXX” on the Experience form; another tech had a different answer.

I’m hoping you have some insight for me. I very sincerely appreciate your time. Perhaps this topic may be a good one to blog about. I imagine I’m not the only one trying to figure this out. Plus, with the fires in Northern California, seems like a lot of guys are getting back into construction after having let their licenses expire.

Kind regards,
Jessica T.

My reply:

Hello Jessica,

Thank you for the kind words.

I can tell you as a former cslb application technician, and a service provider that deals with current application techs, that he would not need to submit his experience with a new application.

On the first page of the app it will ask him to provide any license he is/was associated with. The app tech will look up that license number to verify that he held the same classification previously that is being applied for now and will post the application to the exams.

Having said that, there is always a slim chance that they may ask for an experience outline and verifying documents (depending on the classification being applied for) for this type of application.

~End

Thank you Jessica for your email and allowing me to post it here. Questions from my readers are always welcomed.

California CSLB Contractors Bond Increase

A post by Jon Gottschalk regarding the California CSLB Contractors Bond Increase coming in 2016California CSLB Contractors Bond Increase

As published in our blog last month, the Contractors State License Board (CSLB) is requiring all California contractors to purchase a $15,000 bond by January 1, 2016— a $2,500 increase from the $12,500 amount that was previously required. The additional $2,500 was previously accounted for by an additional requirement to obtain a contractor’s license. Those applying for the license had to post the $12,500 surety bond and proof of financial solvency in the amount of $2,500. Essentially, contractors were required to show that their current assets were greater than their liabilities by no less than $2,500. By increasing the bond amount to include that additional $2,500, the CSLB has removed the burden of proving financial solvency from those who wish to obtain their license.

What does the increased bond amount do to the cost?

Due to the increase, applicants should expect to pay a slightly higher premium for their bond than they would have for the $12,500 amount. California contractor bonds for general contractors with great credit, as well as new applicants start at around $140 for a one-year term. However, rates are slightly discounted when the bond is written for multiple years. Something else to consider is that the premium will also vary depending upon the type of work in which the contractor is engaged. For example, roofing or swimming contractors will most likely pay slightly more than general contractors due to greater risk of a claim being filed against the bond. As has been the case for California bonds, the premium owed is based upon the applicant’s personal credit, so the quote will be subject to underwriting.

What if a $12,500 bond is already in place?

The CSLB is aware that there are thousands of contractors in California and that the majority of their bonds likely do not expire on December 31, 2015. In order to make the increase as simple as possible, they will provide an endorsement authorizing the increase that must be signed by an attorney-in-fact for the surety company.  Although the bond requirement is not increasing by much, contractors that are increasing their bond amount to $15,000 should be prepared to pay a small additional premium to account for the increase before it is approved by the surety company.  Once the increase has been approved by the surety, the endorsement will then need to be filed with the CSLB. Also of note, the endorsement has no bearing upon the bond’s effective dates, so contractors will want to remain aware of the day that their bond expires, at which point the bond will need to be renewed and  electronically filed with the CSLB by the surety company.

What if a $15,000 bond or increase endorsement is not filed?

Failure to have a bond filed with the CSLB in the correct amount may lead to a suspension or even revocation of current licenses, as well as denials for new applicants. Those contractors that have not yet submitted the $15,000 bond to the CSLB should keep the following in mind:

  1. License and bond renewals often do not fall on the same date, so it is important to be aware of both renewal dates and act accordingly.
  2. Many surety companies will notify the bondholder in advance that the bond is coming up for renewal, but it is ultimately the bondholder’s responsibility to ensure that the bond is renewed on time.
  3. The amount of time that it takes for the CSLB to process bonds varies, so contractors will need to allow plenty of time in order to guarantee their bond is filed and that there is no lapse in coverage.

In the event that a lapse in coverage occurs, the contractor’s license may be suspended, and any work that occurs during the suspension may result in further disciplinary action. Further information on suspended and revoked licenses may be found here.

There is also plenty of additional information regarding these bonds available by visiting our California Contractor Bond page or the CSLB website.

New C1 Non Structural Remodel Repair Contractor

C1 Non Structural Remodel Repair ContractorThe CSLB is proposing legislation to create a New C1 Non Structural Remodel Repair Contractor.

It’s about time!!

After years of forcing B General Contractor applicants to withdraw their applications because they couldn’t meet the unrealistic proof of experience requirements, the Contractors State License Board is actually doing something to help the industry! Shocker!!

Friday October 30th, the CSLB Licensing Committee will be holding a meeting to discuss the new C1 non structural remodel repair contractor classification.

It appears they realized that their creation of a list of critical classifications has actually been harming the consuming public, those who strive to become licensed contractors and business owners, the economy, and the construction industry as a whole. They even acknowledged, in writing, that their actions have created an “underground economy.” Can you believe it?!? The almighty, all knowing, all powerful Contractors State License Board admitted they screwed up and failed to fulfill their consumer protection mandate. These are historic times my friends!

C1 Non Structural Remodel Repair Contractor Details

This new C1 classification will allow the license holder to perform work that “provided that no load bearing portion of the existing structure is altered, added or moved; this includes footings, foundations, and weight bearing members.” Basically, it should allow the C1 contractor to bid, contract, and perform work that includes at least two unrelated trades that do not include framing.

Framing has been the nail in the coffin for many B General applicants. A very large percentage of B General applicants over the last 3 yrs have little to no framing experience, and many of those that did, did not have the paper documents to prove that experience. This new C1 classification will change all of that.

Here is the proposed language for the definition of a C1 Non Structural Remodel Repair Contractor:

832.01 Non-Structural Remodel/Repair Contractor A non-structural remodeling and repair contractor remodels and repairs existing structures of three (3) stories or less, built for support, shelter and enclosure of persons, animals, chattels or movable property of any kind; provided that no load bearing portion of the existing structure is altered, added or moved; this includes footings, foundations, and weight bearing members.

If you would like to read the entire committee agenda item, click here.

Looking forward, I see nothing that would stop this new C1 classification from becoming law. When it does become law, their will be a flood of new applicants who will have questions, and as always, I will be here to help them! I will also have C1 contractors exams study kits to prepare those who will be taking the exam.

Stay tuned, I’ll keep you updated on the new C1 Non Structural Remodel Repair Contractor as it unfolds.

 

CSLB Home Improvement Salesperson Registration

The CSLB home improvement salesperson registration law will change on January 1, 2016.

Of all the laws and rules and regulations the CSLB could be working to change, they decided to do something about HIS registrations. What about the myriad of underground regulations the CSLB has created regarding the licensure of targeted classifications?

Press releases like the one below always appear (to me) to be more of a smoke screen than anything else. As if to say “Look at us and what we’re doing to fix a problem very few were aware of… but don’t worry about how we’re profiling a majority of license applications.”

A 1000 applications a month? Seriously? That prompted legislative action? It’s a one page app for goodness sake!

What it really comes down to is … what can the CSLB do to make it easier on themselves. It has nothing to do with any inconvenience on the part of the applicant. The CSLB makes it very clear to almost every applicant who contacts them that they (applicant) are not the priority. For example, emails unanswered, phone calls not returned, ambiguous answers to serious questions, etc.

But hey…. If the CSLB can reduce their workload by processing fewer HIS applications, then WOW… good for them!!

Governor Brown Signs Bill Changing CSLB’s Home Improvement Salesperson Registration Requirements

SACRAMENTO — Home improvement salespersons (HIS) that represent licensed contractors when selling goods and services soon will only have to register once with the Contractors State License Board (CSLB). Governor Edmund G. Brown Jr. signed Senate Bill 561 into law yesterday, simplifying the HIS registration process to a single registration while still allowing salespeople to represent multiple employers.

Anyone who solicits, sells, negotiates, or executes home improvement contracts for a licensed contractor outside of the contractor’s normal place of business must be registered with CSLB as an HIS (Business and Professions Code section 7153).

The law takes effect January 1, 2016, and removes the current requirement that an HIS register separately with CSLB for each contractor that employs them.

The bill, authored by Sen. Bill Monning (D-Carmel) and sponsored by CSLB, will simplify and quicken the registration process in response to the rapid growth in the number of HIS applications, particularly for employees who work in the solar industry. CSLB received more than 1,000 HIS applications per month in fiscal year 2014-15, a 40 percent jump compared to the average for the previous three years.

In addition to the single registration provision, SB 561 will:
·         Require a contractor to notify CSLB in writing prior to employing a registered HIS, and when employment ceases;
·         Allow CSLB to accept an electronic application and signature from an HIS applicant;
·         Require an HIS to have a current and valid registration with CSLB before making sales calls and transactions on behalf of a contractor; and
·         Provide that registrations will be valid for two years from the month of issue.

CSLB staff is already at work putting systems in place for the new registration process. More information will be available in the weeks to come on CSLB’s website.

End press release

I would provide a link to this press release on the CSLB website, but apparently they send out press releases before updating their public website and there is no link for me to provide.

Who should certify your CSLB experience

Who should certify your CSLB experienceSo who should certify your CSLB experience and who shouldn’t?

And how should your trade experience be outlined on the license application.

Other questions are:

  • How many certifiers do I need?
  • Can my dad, mom, uncle, or brother be my certifier?

These are common questions that I’m asked all the time. And although it seems like this aspect of the license application is somewhat of a daunting task, it’s really not that bad.

Who should certify your CSLB experience?

  • If you are submitting experience as an employee, do not check the “self-employed” box in Line two. Enter the employer’s business name, license number, and business address. The certifier in this case could be the license holder, officer on the license, foreman or supervisor, fellow employee, or anyone who has first-hand knowledge of that experience.
  • If you are submitting experience as self-employed, do check the “self-employed” box in Line two, and leave the employer name, license number, address boxes blank. The certifier in this case could be a business associate, another journeyman, or a contractor listed in the same classification or above. I would avoid checking the “client” box because most people are not working for the same client 40 hours a week for four years. If you are, you should probably be on the payroll.

How many certifiers do I need?

You only need one unless your certifier is not certifying a full four year period. If you have one certifier that has first-hand knowledge of only two years of experience, then you would need a second certifier to cover the remaining two years. Submitting more than one work experience page for the same time period with different certifiers is not a benefit to you. It does not increase your chances of the application being accepted (aka “posted”).

Can your dad, mom, uncle, or brother be your certifier?

Yes. As long as they have first-hand knowledge of your experience and are qualified to know if your experience is at the journeyman level. The title they would select would most likely be “Business Associate” unless they are licensed. Then you would select the Contractor box and enter their license number.

What if you can’t use your employer as your certifier because it might put your employment status in jeopardy?

You could use a fellow employee or foreman/supervisor as your certifier. Submit a letter with your application stating that you do not want the CSLB contacting the employer directly because it could jeopardize your employment. The CSLB isn’t in the business of getting people fired from their jobs.

How should your trade experience be outlined on the license application?

The application states: “In the space below, list all specific trade duties applicant performed or supervised in the classification for which he/she is applying.”

This implies that the certifier has to fill out the experience outline. Although the implication is there, it is acceptable for you to complete the experience outline and have your certifier sign-off on it.

The outline should be generic, straight forward, and trade specific. Begin the outline with “Experience includes….” Then describe the trade duties you perform/supervise on a daily basis. Do not list administrative duties. These include, reading plans, getting permits, contacting clients, etc.

So who should certify your CSLB experience and who shouldn’t?

Hopefully I’ve laid it out in a way that explains it in a clearer, more understandable way. If you have questions regarding this topic, feel free to contact me. And remember, I do offer an application review service for only $50.

Critical Classification Application Under Review

Critical Classification Application Under ReviewI’m often asked, pretty much daily, what should an applicant do when they are dealing with a critical classification application under review.

If you are applying for the C10 Electrical, B General Building, A General Engineering, C20 HVAC, etc. and your application is under review, this email Q&A and I had with a C10 applicant might also help you or somebody you know.

Q. Based on my application you looked at, what are the odds of them accepting it without requiring more documentation?

A. Slim to none. They’ve been asking all applicants with a critical classification for additional documents.

Q. If the odds are very low they accept as is then what do they increase by if I include documentation (1099s, permits, materials receipts, tax returns) with the application on the first submittal or should I wait for them to ask?

A. You should submit any/all documents you have with the app. If they find it acceptable, they’ll schedule you for the exam. If not, they’ll ask for more documentation.

Q. I have lots of different documentation but not a fully complete timeline record of EVERYTHING. Do they show any leniency to applicants who include lots of information from the start?

A. Not that I’ve experienced.

Q. I do have enough documented experience over the last ten years to get a B but would only consider that if it was a stepping stone which made it easier to get the C-10 later. Do you think this would help me to get the C-10 if I put off applying for 2 to 3 years? Could having a B potentially work against me getting a C-10 in two to three years?

A. To get either you’ll have to provide the written documentation. The B requires experience in framing and at least two unrelated trades. The C10 could be easier to get if your experience is directly and solely related to the c10. If you were to get the B and then apply for a c10 in a couple three years, it might be harder to show at least 4 yrs of c10 experience. Also, if you have the B you cannot bid on or sign contracts for a single trade like the c10.

Q. Would it help to get sign offs on shorter term experience from more B contractors who I have done electrical for?  This goes back to the more information included with the original submittal, does it decrease the odds of them requiring more documentation / increase the chances they accept the application as is.

A. Submitting more work experience forms does not generally help or hurt. They’ve made the certifier a moot point because of the documentation requirement.

Q. Does it carry any weight if I include some projects done for homeowners and include their permits, check written to me, materials receipts, and invoice?

A. That would help. But the permit would have to be in your name in order for you to get “credit” for it.

Q. Do you think submitting a 1099 for experience where the employer box is checked is a red flag and should be used as self-employment experience instead? I know that the experience with the C-10 i work for definitely is an employee relationship rather than a contract type, I show up when he tells me to show up and act on his direction under his supervision.

A. How does the CSLB look at 1099s in this regard? As a 1099 “employee” you are working as self-employed. Only if you are on payroll for the company would you be considered an employee.

Q. Based on the letter you attached in your previous email showing request for more info to that applicant,  if I were to get a similar letter and respond with not enough documentation then would that void my application or would there be another opportunity to submit more? When does the application usually drop dead?

A. If you did not submit enough documentation to satisfy the licensing department they would send you an “options letter.” This letter gives you the option to withdraw the app, use some other qualified individual to act as the qualifier on your license, or go to a formal investigation. If you choose the formal investigation, they will send you to the exams and an investigator will be assigned. That investigator will ask you for more/the same documentation that the licensing unit asked for. The investigator will also contact your certifiers to verify your experience. If the investigator does not approve of your experience you can either withdraw the app or they will deny your app. A denial means you’d have to wait a year before reapplying, and you’d have a denial flag on your name in their system.

Q. If I do submit my application and it ultimately gets tossed then can I re apply later with other documentation? Does the CSLB keep a copy of previous applications on file and refer back to those in this sort of scenario?

A. As answered in Q6, a denial has a one year waiting period. If you withdraw the app on your own, you can reapply at any time. The new app would be subjected to the same documentation and you’d have to re-submit everything plus any new documentation.

Q. The above question sorta relates to if it helps to apply for a B first and what experience is submitted with that. I would hate to shoot myself in the foot.

A. The issue is… when you apply for an additional classification, they will not accept experience that you submitted previously for the original classification. If your contracts are only for C10 work, you’ll want to apply for the C10 with the initial license.

Q. If I do include lots of documentation with the application before they ask then could this tick off the reviewer by being overwhelmed with paperwork or does it make me look more serious and more well prepared? (sort of already asked this question above)

A. Better to send everything with the initial submittal. Saves them from having to send you a letter requesting the docs and having to sit on the application until you reply to their letter.

Q. How would you approach this if you were in my shoes?

A. Create a chronological binder with all the documentation I had, submit it with the application, cross my fingers.

Q. Do you think I should just suck it up and do another year working for the C-10 guy (1099) or would you suggest a different route to document experience if you think I should wait to have a better documented history?

A. This all depends on the documentation you have now. If you feel it shows a solid four years (minimum) of experience, I’d say apply now. If you went thru the app process and the cslb said you needed one more year, withdraw your app work another year, then resubmit everything.

Q. Guessing you have seen others in my same predicament so what has made the biggest differences for them being able to get their applications accepted?

A. How well prepared your documentation is.

Q. The C-10 guy I work for has mentioned partnering with me a few times. Would there be some mid-term benefits to going this route and getting on his license then applying for my own later? I am not sure how this works but have heard of others getting brought in that way. The guy is a bit hard to work for / with so this would be a last resort but good to know the answers if it comes to that.

A. This scenario is included in the cslb “options” letter. You could use someone else to be your qualifier. After X amount of years, you could apply to replace that qualifier on the license.

So if you find yourself with a critical classification application under review, let me know and we can discuss your specific circumstances. I offer a very affordable consultation service. Click here if you’d like to discuss what you can do.

S Corporations and Salaries

Continuing my research in comparing an S corporation to a sole proprietor, I found this article on nolo.com that discusses how to pay yourself, other officers, and shareholders.

S Corporations and Salaries: How much should I pay myself?

An S corporation (also called a Subchapter S corporation) is a small corporation that has elected to be taxed much the same as a partnership by the IRS. An S corporation is a pass-through entity—income and losses pass through the corporation to the owners’ personal tax returns. Many small business owners use S corporations. One of the biggest reasons is that an S corporation can save a business owner Social Security and Medicare taxes. However, this has become a hot button issue for the IRS.

An S corporation shareholder who performs more than minor services for the corporation will be its employee for tax purposes, as well as a shareholder. In effect, an active shareholder in a S corporation wears at least two hats: as a shareholder (owner) of the corporation, and as an employee of that corporation. This allows for savings on Social Security and Medicare taxes because such taxes need not be paid on distributions of earnings and profits from the corporation to its shareholders. Thus, to the extent they pay themselves shareholder distributions instead of employee salary, S corporation shareholder/employees can save big money on payroll taxes.

It’s up to the people who run an S corporation—its officers and directors—to decide how much salary to pay the corporation’s employees. When you are employed by an S corporation that you own (alone or with others), you’ll be the one making this decision. In fact, 70% of all S corporations are owned by just one person, so the owner has complete discretion to decide on his or her salary.

However, an S corporation must pay reasonable employee compensation (subject to employment taxes) to a shareholder-employee in return for the services the employee provides before a distribution (not subject to employment taxes) may be given to the shareholder-employee.

Unfortunately, many S corporation owners have gone overboard and had their corporations pay them no employee compensation at all, thus avoiding having to pay any payroll taxes. The IRS Inspector General found that in 2000 about 440,000 single shareholder S corporations paid no salary to their owners, costing the government billions in lost payroll taxes. As a result the IRS stepped up enforcement on this issue and audited thousands of S corps that paid their owners little or no salary.

If the IRS concludes that an S corporation owner has attempted to evade payroll taxes by disguising employee salary as corporate distributions, it can recharacterize the distributions as salary and require payment of employment taxes and penalties which can include payroll tax penalties of up to 100% plus negligence penalties. The IRS will do so if it concludes that the corporation paid the employee unreasonably low compensation for his or her services. For example, a CPA who incorporated his practice took a $24,000 annual salary from his S corporation and received $220,000 in dividends which were free of employment taxes. The IRS said that his salary was unreasonably low and that $175,000 of the dividends should be treated as wages subject to employment taxes. The court upheld the IRS’s power to recharacterize the dividends as wages subject to employment tax. (Watson v. United States, (DC IA 05/27/2010) 105 AFTR 2d ¶ 2010–908.)

Thus, as a general rule, it is advisable to have your S corporation pay you at least some salary–which can be on the low end of the reasonableness scale. How low can you go and still pay yourself a reasonable salary? There are no precise guidelines. IRS officials have stated that they make the determination on a case-by-case basis. Among the factors the IRS and courts consider are:

  • the duties performed by the employee
  • the volume of business handled
  • the type of work and amount of responsibility
  • the complexity of the business
  • the time and effort devoted to the business
  • the timing and manner of paying bonuses to key people
  • use of a formula to determine compensation
  • the cost of living in the locality
  • the ability and achievements of the individual employee performing the service
  • the pay compared with the gross and net income of the business, as well as with distributions to shareholders
  • the company’s policy regarding pay for all employees, and
  • the payment history for each employee.

After examining all the circumstances, they establish a range of reasonable salaries, from low to high. In one case, the IRS concluded that a reasonable salary for an Arkansas certified public accountant was $45,000 to $49,000. The accountant in that case had paid himself no salary and received $83,000 in corporate distributions. The IRS used salary information from a large financial services recruiting firm to determine what was reasonable. (Barron v. Comm’r, T.C. Summ. 2001-10.) Some IRS offices have software that provides salary information for a variety of occupations throughout the country. An S corporation (also called a Subchapter S corporation) is a small corporation that has elected to be taxed much the same as a partnership by the IRS. An S corporation is a pass-through entity—income and losses pass through the corporation to the owners’ personal tax returns. Many small business owners use S corporations. One of the biggest reasons is that an S corporation can save a business owner Social Security and Medicare taxes. However, this has become a hot button issue for the IRS.

An S corporation shareholder who performs more than minor services for the corporation will be its employee for tax purposes, as well as a shareholder. In effect, an active shareholder in a S corporation wears at least two hats: as a shareholder (owner) of the corporation, and as an employee of that corporation. This allows for savings on Social Security and Medicare taxes because such taxes need not be paid on distributions of earnings and profits from the corporation to its shareholders. Thus, to the extent they pay themselves shareholder distributions instead of employee salary, S corporation shareholder/employees can save big money on payroll taxes.

It’s up to the people who run an S corporation—its officers and directors—to decide how much salary to pay the corporation’s employees. When you are employed by an S corporation that you own (alone or with others), you’ll be the one making this decision. In fact, 70% of all S corporations are owned by just one person, so the owner has complete discretion to decide on his or her salary.

However, an S corporation must pay reasonable employee compensation (subject to employment taxes) to a shareholder-employee in return for the services the employee provides before a distribution (not subject to employment taxes) may be given to the shareholder-employee.

Unfortunately, many S corporation owners have gone overboard and had their corporations pay them no employee compensation at all, thus avoiding having to pay any payroll taxes. The IRS Inspector General found that in 2000 about 440,000 single shareholder S corporations paid no salary to their owners, costing the government billions in lost payroll taxes. As a result the IRS stepped up enforcement on this issue and audited thousands of S corps that paid their owners little or no salary.

If the IRS concludes that an S corporation owner has attempted to evade payroll taxes by disguising employee salary as corporate distributions, it can recharacterize the distributions as salary and require payment of employment taxes and penalties which can include payroll tax penalties of up to 100% plus negligence penalties. The IRS will do so if it concludes that the corporation paid the employee unreasonably low compensation for his or her services. For example, a CPA who incorporated his practice took a $24,000 annual salary from his S corporation and received $220,000 in dividends which were free of employment taxes. The IRS said that his salary was unreasonably low and that $175,000 of the dividends should be treated as wages subject to employment taxes. The court upheld the IRS’s power to recharacterize the dividends as wages subject to employment tax. (Watson v. United States, (DC IA 05/27/2010) 105 AFTR 2d ¶ 2010–908.)

Thus, as a general rule, it is advisable to have your S corporation pay you at least some salary–which can be on the low end of the reasonableness scale. How low can you go and still pay yourself a reasonable salary? There are no precise guidelines. IRS officials have stated that they make the determination on a case-by-case basis. Among the factors the IRS and courts consider are:

  • the duties performed by the employee
  • the volume of business handled
  • the type of work and amount of responsibility
  • the complexity of the business
  • the time and effort devoted to the business
  • the timing and manner of paying bonuses to key people
  • use of a formula to determine compensation
  • the cost of living in the locality
  • the ability and achievements of the individual employee performing the service
  • the pay compared with the gross and net income of the business, as well as with distributions to shareholders
  • the company’s policy regarding pay for all employees, and
  • the payment history for each employee.

After examining all the circumstances, they establish a range of reasonable salaries, from low to high. In one case, the IRS concluded that a reasonable salary for an Arkansas certified public accountant was $45,000 to $49,000. The accountant in that case had paid himself no salary and received $83,000 in corporate distributions. The IRS used salary information from a large financial services recruiting firm to determine what was reasonable. (Barron v. Comm’r, T.C. Summ. 2001-10.) Some IRS offices have software that provides salary information for a variety of occupations throughout the country.

http://www.nolo.com/legal-encyclopedia/s-corporations-salaries-an-irs-hot-button-issue.html

by: Stephen Fishman, J.D.

End of article

What will be interesting is what, if anything, will happen after the next presidential election. Several of the candidates are pushing for a flat tax or a use/consumption tax. Personally speaking, I agree with the flat tax, but it is something that would actually work.

Again, if you are interested in creating a corporation and incorporating your construction license, I can help. Send me an email and we’ll discuss your options.