A friend told me his accountant is retiring. I gave him my accountant’s name and number. He said he’d contact her to see if she would take his business, as he is doing something a little unorthodox.
I don’t have all the details, but basically he is paying his girlfriend to come in for an hour a week. No big deal, except for the fact that he is paying her $550.00 an hour. All applicable taxes are being taken out, etc.
I told him he could take a $2,000.00 draw each month and just give that to her, but he said that would not work for him. (might that affect his tax bracket maybe?)
He said his previous accountant was “uncomfortable” but went along. Now I’m all curious. Is there a maximum wage? Is this fraud of some sort? How could this possibly be better than just taking a draw and giving her the money?
I am a business owner, but obviously know nothing about accounting.
(1) It may be illegal. It’s a messy grey area which is probably why the previus accountant wasn’t happy about it.
(2) No, there’s no maximum wage. However, if the IRS sees people wildly overpaid, they may get suspicious, and they may have reason to be here.
(3) Maybe illegal, maybe not. The first major question is, ‘Does the girlfriend do any actual work?’ Coming in for an hour a week implies that’s it’s basically a fiction, and that could be fraudulent, or tax evasion, because…
(4) This is presumably being done because the money she earns is taxes at a lesser rate than it would otherwise be.
My guess is that by paying her a per hour rate for services he gets to treat her as a contractor rather than an employee. That means he’s not responsible for benefits, among many other things. A huge saving.
My guess is that the money he “pays” his girlfriend is being deducted as a business expense, thereby reducing the amount of business income, and the taxes paid thereon.
I don’t believe that there is anything resembling a maximum wage law currently on the books, but there apparently have been such things proposed historically, like during WWII.
$550 an hour is not greatly out of line for a very skilled consultant’s fee. When I was working for a consulting company, the company billed $400-ish/hour for my time (of which I was paid a tiny fraction) and I was a dumb-shit fresh out of school.
Of course, if I was the IRS, If I heard of someone being paid that much for an hour of work, I would assume some sarcasm quotes around the term “girlfriend”.
IANAL and I’m speaking about Canadian experience, but I wanted to do something similar with my own business and my wife. Accountant told me that if we got audited and the Canadian tax folks thought the scheme was devised simply to avoid the higher tax rate I would have to pay (which it was), we would get charged interest and penalties for the difference. So I didn’t bother. No, really.
This kind of arrangement is fraudulent when you’re a government official using the taxpayer’s money to pay your girlfriend. However, I don’t see why a privately held company can’t pay whatever they want to anybody to do anything, or nothing. Remember, if the company’s taxes are reduced by booking this as payroll expense, the girlfriend has to pay income tax on that amount. IANACPA so there could be some subtle issue here but the IRS isn’t in the business of deciding whether any individual is too highly paid. Otherwise hundreds of companies that had massive losses would be investigated for paying their CEOs millions. Newt Gingrich made $1.6 million in “consulting fees” from Freddie Mac for basically being Newt Gingrich.
As long as your friend’s business observes GAAP I have no idea why an accountant would care how much someone is paid.
You can run afoul of deductibility rules. According to the IRS to be deductible the compensation must be ordinary and necessary, reasonable in amount and based on services rendered.
$550 per hour may be completely reasonable for some services, and totally out of line for others. I’d be nervous if I were that guy’s accountant.
In addition to the ordinary necessary rules, there is also the “economic substance doctrine” that might come into play. For example, if she is not actually doing any work, or if the payments are deposited in a joint account so that the boyfriend uses the money to pay his own bills… those kinds of things can lead the IRS to argue that the transaction has no economic substance and is just a way to shift money around.
The only other thing like a maximum wage in the tax code is the rules on “reasonable compensation,” which are sometimes trotted out for C corporations using excessively high wages to avoid paying dividends, or on S corporations using excessively low wages to avoid payroll taxes. I don’t know that reasonable compensation rules are particularly relevant to a non-shareholder, though.
I’m getting the “shifting money around” vibe. Although I referred to her as his girlfriend, that’s only because that’s what he calls her. He is divorced, will likely not marry again, but has been with his “girlfriend” at least a decade.
The city of Bell, California got into serious trouble when the city leaders gave themselves salaries of over $500K apiece. Most of them were arrested and charged with voter fraud.
Well, yeah, any business can set maximums internally. That has nothing to do with any law.
And even within the federal government, that would not apply to contractors. POTUS makes $400,000 a year. Using a normalized year of 2000 hours, that’s only $200 per hour. I’ll bet zillions of specialists hired by the government make more than that.
At one of my former jobs, my boss was paying his wife for absolutely nothing. I had to enter her in for 8 hours a day, 5 days a week. And she never was there. She did do some design work once but it should have been contract. Yet she continued getting paid. She did have to show up for drug tests as he had her on the payroll. And her urine was very dark orange, almost red. Giving that her license plate read KORBELS I kind of wondered.
Then in my next job, I had to do payroll. So I knew everyone’s pay. Then the CEOs added their elementary school children into the payroll and paid them $5,000 each one month. Then they did it again about 2 months later.
But I had already nailed them with their hiring of me as a contractor when by law I was a regular employee. I got my unemployment. Didn’t want to go further.
Our state gov. titles have minimums and maximums. There’s a pay grade table that we follow. That’s for classified employees. Typically staff positions like secretaries, programmers, accounting staff etc. We’re also allocated so many of each that we can hire. For example 40 Secretary I’s, 30 Admin Secretary and so on.
Once in awhile someone will shift from Classified to Non-Classified for more money. But, Non-Classified aren’t protected like Classified. Non-Classified can be terminated pretty much for any legit reason like non performance, bad annual reviews and so on.
IRS Section 162(m) limits the pqy to the CEO & next 4 highest-paid executives to $1 million per year. Actually, it doesn’t limit it to that – it just doesn’t allow a corporate tax deduction for compensation over $1 million per person. So there’s a loophole: a corporation can pay them more, if it is willing to also pay the taxes on that excess compensation.
And there’s even another loophole on top of that. That section contains an exemption for stockholder-approved qualified performance-based compensation. So if the corporation comes up with a plan for executive bonuses or stock options or similar compensation that is somehow linked to something like stock price or annual sales, etc. and gets the stockholders to approve it (and stockholders nearly always vote in favor of such plans), then they are exempt from the $1 million maximum. It’s pretty easy to write such plans so the executives always get those bonuses (and the IRS hardly ever audits this, anyway). There are cases of companies going bankrupt and executives still getting their ‘performance’ bonuses.
So there was once an attempt to set a maximum pay, but in fact it’s mostly fiction.
No. My Congressman Martin Sabo (now retired) was the one pushing this, and I have talked to him about it. His reasons were really related to worries about executives being too insulated by excessive compensation, and managing companies for their own personal benefit rather than that of the stockholders (and the country’s economy).
He was concerned about the big gap between executive pay and worker pay, and the detrimental effect on worker morale & thus productivity. Also with executive compensation that was not aligned with the performance of the company, leading to concentration on short-term gains, with little thought to investment in the company for long-term profitability.
He felt that linking executive compensation to company performance, and making stockholders view & approve the compensation plan would work to solve these problems. He did say that he had considered just setting a maximum wage (something like 100 times the minimum wage, which is where the $1 million per year came from), but he questioned the constitutionality of such a limit.
My guess is that there’s an “arm’s length” thing going on here. If I somehow manage to convince a company to pay me $200 an hour to do stuff that common sense tells you is only worth $20 an hour, but there are no signs that our relationship is anything other than professional, then there’s probably little that can be proven. Now, if I’m getting paid $200 an hour to keep a seat warm because my sister is married to the CEO and sis is threatening divorce if I lose my job, then there might be a case for unreasonable compensation.