Pass-Through Tax Compliance: S-Corp Reasonable Compensation, §704(b)/752 Basis & QBI Audits

Upon receiving IRS Letter 566 and Information Document Request (IDR) #1 for Sharma Surgical PC, Tax Controversy Partner Sarah Jenkins began reconstructing the 2022–2023 W-2 reasonable compensation and S-Corporation distribution schedules for sole shareholder Dr. Anya Sharma. Anya Sharma. Anya Sharma. Anya Sharma's highly successful surgical practice, and demanded detailed financial records for the 2022 and 2023 tax years. The specific focus: 'Shareholder-Employee Compensation and Distributions.' Dr. Sharma, a brilliant surgeon and the sole shareholder, had reported a W-2 salary of $120,000 for both years, while simultaneously taking S-corporation distributions of $850,000 in 2022 and $920,000 in 2023. IRS Revenue Agent Evelyn Reed's cover letter explicitly referenced 'potential underpayment of FICA taxes due to unreasonable compensation.' Our immediate task was clear: reconstruct the rationale for Dr. Sharma's W-2, prepare a robust defense against reclassification, and meticulously analyze PSI's Accumulated Adjustments Account (AAA) and any potential Accumulated Earnings and Profits (AEP) to preempt further audit adjustments. This initial IDR signals Phase I of what promises to be a complex, multi-entity IRS examination.