The IRS is looking at consultant and other professional income taxes and has issued new audit guidelines. One of the issues they are looking for is shifting income from one entity to another. The following is an excerpt from the IRS Consultants Audit Guide. For help with dealing with IRS audits please call Matis at 646-580-1099 or email@example.com.
Shifting or the Assignment of Income / Substance versus Form
Closely held or one-man personal services corporations, including business consultants, have assigned or shifted income earned by themselves, as individuals, or their closely held corporations, to another entity in order to reduce their income and or self-employment taxes. The taxpayer may shift income earned by one entity to a related entity in order to offset net operating losses of a related entity or in some cases to circumvent the Roth Individual Retirement Account limitations. Subsequent to this shifting of income, the taxpayer may take a relatively small salary from the entity (that received the assigned income) in relationship to the amount of income shifted.
To whom is the client/customer contracting the services?
- Is the Taxpayer an S corporation or a partnership and yet the contract requires the services of a particular employee/owner?
- Is the contract voided upon the death of a particular employee of the Taxpayer?
- Do the terms of the agreement call for services that only one employee/owner is capable of performing?
- The examiner should trace the consulting fees per the contract to the Taxpayer’s books and records.
- Request copies of all tax returns that are considered related returns of the taxpayer because the taxpayer has control. As outlined in IRM 18.104.22.168.4.3, the examiner should evaluate copies of tax returns of significant shareholders or partners (greater than 20% direct or indirect ownership) for:
a. examination potential (including issues unrelated to the corporate or partnership return),
b. the proper treatment of related transactions with the corporation or partnership, including losses from related parties, and
c. The likelihood of diverted funds.