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  Article one discusse s the three-month auto mileage substantiation example the IRS has approved   and Article two talks about reasonable compensation for an S Corporation and how it may cause your business problems going forward.

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Did you know that the IRS has given examples of acceptable partial year mileage logs?  (I didn't until recently.)

Under IRS Reg. Section 1.274-5T(c)(3)(ii)(C) the IRS has actually said as an example that maintaining an auto log for three consecutive months showing a percentage of business auto use plus showing via paid bills and other receipts that your business continued at the same rate for the rest of the year will provide sufficient corroborative evidence if other circumstances don't change (getting a second car for the business, for example.)

The IRS also gives another example of keeping a log for the first week of every month for the whole year as also providing corroborative evidence, but what is the point of doing this - you might as well keep a log for the whole year!

Here are the basics of how the IRS describes the three-month test:

*The taxpayer uses her vehicle for business use.

*She and other members of her family use the vehicle for personal use.

*The taxpayer keeps a mileage log for the first three months of the taxable year, and that log shows that she uses the vehicle 75 percent of the time for business.

*Invoices and paid bills show that her vehicle use is about the same throughout the year.

According to this IRS regulation, this three-month sample is adequate to prove 75 percent business use.

Click on the link below to look at the actual regulation as the IRS states it (thanks to the Bradford Tax Institute for the Section and info on this easier way to substantiate auto mileage.)

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Issue 125

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What Is Reasonable Compensation?
For small businesses formed as an S Corporation and with plenty of profits, reasonable compensation is a term you may want to be familiar with. 
Many small businesses have organized as an S Corporation form of entity.  In many cases, the S Corp election allows a business owner to save money on self-employment taxes, especially if they are operating as a sole proprietor.  S Corp profits, or distributions, are not subject to payroll taxes. 
If you are a business owner taking a salary and contributing substantially to the operations of the business, you may think that you should just take the distributions and forget the salary.  After all, think how much you would save in payroll taxes, plus all your income is subject to the 20% pass-through deduction under Sec 199A starting in 2018.  But this has already been tried and shot down by the IRS in the courts.  And this is where the term reasonable compensation comes in.
The IRS requires that business owners that perform a substantial contribution to the business be paid a salary according to a number of factors.  This is called reasonable compensation. You can't pay yourself below market and take a large amount in distributions. 
The IRS has issued a fact sheet that describes the guidelines that can be used to determine reasonable compensation. They include employee training, experience, duties, time spent, history of distributions, bonuses, and many other factors. 
There are also reasonable compensation ramifications for C Corporations as well. 
With the changes to S Corps in the Tax Cuts and Jobs Act as far as the 20% pass-through deduction, the IRS has said indirectly that reasonable compensation audits will probably increase in the future. This will probably make reasonable compensation a concern for your S Corporation business. If so, please feel free to reach out and let us know how we can help.  

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Brian T. Stoner, CPA 
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