TN 14 (04-12)

Citations:

Social Security Ruling 63-36c, C.B. 1963, p. 48,

and Social Security Ruling 66-31c, C.B. 1966, p. 65.

A. Forming a corporation

The rules you must use to determine whether a business is a corporation changed for businesses formed after 1996. A business formed before 1997 and treated as a corporation under the old rules will generally continue to be treated as a corporation. The IRS and SSA treat the following businesses formed after 1996 as corporations:

• Certain banks;

• An insurance company;

• Certain foreign businesses;

• A business wholly owned by a state or local government;

• A business formed under a federal or state law that refers to it as a corporation, body corporate, or body politic;

• A business formed under a state law that refers to it as a joint-stock company or joint-stock association;

• A business specifically required to be taxed as a corporation by the Internal Revenue Code (for example, certain publicly traded partnerships); and

• Any other business that elects to be taxed as a corporation (for example, an LLC which elects corporate treatment).

See IRS Publication 542, Corporations for more information.

B. Use of corporate form to secure coverage

1. Background

If a corporation is recognized under state law and operates a business in a bonafide manner, SSA may not disregard it despite the fact that it may have:

• been formed for the purpose of securing coverage; or

• altered the distribution of the business' income.

When the facts establish that a properly organized corporation exists, that it operates the business as the owner and derives income, and that a claimant receives remuneration as an officer or because of services for the corporation, it necessarily follows that the remuneration constitutes wages for employment. The fact that a corporate business consists only of renting property or making and holding other investments and that the business was previously conducted by the claimant individually or by members of his or her family, will not in itself preclude a finding of employment.

2. Reviewing the corporation status

Questions may arise about employment, wages, or other earnings allegations situations involving a close or family corporation. For example, someone may have manipulated records to show payment of wages in inflated amounts. Court precedent has well established SSA's right to look beyond form to substance in evaluating the operations of a corporation as they affect any aspect of a claim for benefits.

C. Developing close or family corporation cases

Develop close or family corporate situations to answer the following questions:

1. Did the claimant render the alleged services?

2. Did the corporation pay the remuneration?

3. Is the corporation a functioning business entity?

4. Did the corporation comply with state entity laws?

D. Developing evidence and issues

Only request evidence or develop an issue that will assist in determining the facts in the case. Below, we list various types of evidence and issues to develop:

• A copy or certification of the charter that should indicate the establishment date of the corporation, the general business purpose, and the composition of its management.

• Evidence to show that the corporation complied with state laws. Failure to meet one or more of these state requirements would not necessarily negate the corporate existence. However, if there is obviously little or no compliance with the usual requirements of corporate formation, you may question the legal existence of the corporation. If a question arises as to whether the corporation has materially met the legal requirements of state law, refer the question to the Office of General Counsel for a legal opinion. For the policy on requesting legal opinions, refer to GN 01010.815.

• Does the corporation have an active bank account separate and apart from the individual's or family's personal account? Or, is there commingling of funds? Though not conclusive, such commingling indicates a lack of separation between the corporate and personal enterprise.

• Are materials and services needed in the corporate operation purchased in the corporate name? Examine bills, receipts, and any other documents to verify the corporation's business activities.

• Did you contact the suppliers of services and materials to verify that purchases were made in the name of the corporation and were paid for by the corporation (e.g., by corporate check)?

• Whose credit is pledged in connection with the enterprise? The corporation's or the individual's?

• Are leases, insurance policies, and licenses executed in the corporation's name? If not, obtain an explanation.

• Obtain Form SSA-795 (Statement of Claimant or Other Person) from the individual concerning the person's services to the corporation and, if applicable, the services prior to incorporation. The person's business transactions should reflect his or her corporate capacity after incorporation. Has he or she been transacting business in the name of the corporation or in his or her individual name? When the individual managed a business as both a sole proprietor, and subsequently, as a corporate officer, his or her services may not have altered appreciably.

• Contact persons who know of the individual's activities, and the capacity in which the person has acted (e.g., tenants, clients, or customers). The corporate records may indicate actual rendition of services (e.g., entries in the individual's handwriting may be evidence of bookkeeping services, or sales slips may show sales activities).

• What are the resources of the corporation's income, and who receives the proceeds of the business transactions? Does the corporate bank account reflect the accretion of income, or is the income commingled with the individual's personal funds?

• Obtain copies of corporate minutes and resolutions pertaining to the individual's salary, and that of other family members. Were the salaries for holding office, or for rendering services? Are the minutes and resolutions consistent with the reporting and allegations?

• Did the corporation file tax returns as required? Obtain copies of tax returns for pertinent years prior to the year of entitlement. The years that are pertinent to an investigation will depend on the facts in the individual case. If there is little reason to question the alleged salary payments, the last corporate tax return may be sufficient. However, if the reported salary is highly questionable, as in a case showing a sudden and unexplained increase in salaries to corporate officers, the tax returns for several previous years may be necessary to get an accurate picture of the corporation's financial progress.

• The tax returns should support the alleged salaries to the officers by showing these amounts as compensation of officers. The tax return is further useful to determine if the corporation had sufficient income to pay the alleged salaries, if it had any earned surplus to pay alleged dividends, how much time an officer devotes to business activity, etc. It is not unreasonable or impossible to pay a substantial salary despite a net loss for the taxable year, as salaries do not have to be paid from current earnings. This rule is applicable within reasonable limits. Evaluate within the total financial framework.

• Where the tax returns and supporting evidence raise a question that the alleged salaries were actually or constructively paid, examine the pertinent corporate books and records. The problem may be to verify the corporate income or the payment of salary to the individual. In verifying the payment of salary, SSA is sometimes confronted with a difficult problem since bookkeeping entries can be evidence of payments, although there has been no actual transfer of assets. This is sometimes the case where the individual uses the corporation's bank account as a depository of his or her personal funds as well. While such commingling of funds does not determine the issue of wage payment, it requires the closest examination and supporting evidence to establish actual payment.

• Obtain any other pertinent evidence necessary, such as personal tax returns, to verify the inclusion of salary for personal income tax purposes, etc. If possible, make at least one personal contact with the place of business.

SSA’s concern is that the individual does not obtain coverage when the corporation is simply a conduit for an individual's personal funds. In these cases, the corporation does not engage in any real business activity, and its primary or sole source of funds is the personal loans to it by the individual.

E. Evaluating evidence

In the close or family corporation case, base the determination on the findings, and the findings on the evidence. The determination must agree with the findings where the corporation unquestionably exists, functions, earns income, pays salary, and the remuneration is justifiable.

On the other hand, where the weight of evidence establishes that a corporation is nothing more than a legal fiction, without substance or function, or that its alleged income and distributions are unreasonable and unsubstantiated, the determination must also agree with these findings.

In the final analysis:

• decide each case on its own merits;

• obtain evidence in questionable cases to render a reasonable determination and to avoid an arbitrary or capricious decision; and

• the facts must support these findings and the findings must support the final determination.

F. Small business corporations (S corporations)

Certain small business corporations may elect not to be subject to federal corporation income tax as permitted in Subchapter S of the Internal Revenue Code. Shareholders of such corporations are not engaged in a trade or business as explained in RS 01802.015.

Small business corporations that make this election are called S corporations. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income.

Each shareholder of an S corporation must include on his or her individual tax return his or her pro rata share of the annual corporate income, regardless of whether such income is distributed or undistributed. The electing corporation, although not liable for corporate income tax, must file an informational return on IRS Form 1120-S (U.S. Income Tax Return for an S Corporation).

The purpose of this law is to aid and foster small business corporations. Rather than taxing the S corporation, the individual shareholders are taxed in a manner similar to the way partnership earnings are taxed. In general, this treatment permits businesses to select the form of business organization without an additional tax burden.

To qualify for S corporation status, the corporation must:

• be a domestic corporation;

• have only allowable shareholders (including individuals and certain trusts, and estates, but not partnerships, corporations, or non-resident aliens);

• have no more than 100 shareholders;

• have one class of stock;

• not be an ineligible corporation (i.e., certain financial institutions, insurance companies, and domestic international sales corporations); and

• submit IRS Form 2553 (Election by a Small Business Corporation) that is signed by all of the shareholders.

The election to be an S corporation may be revoked if the owners of the shares vote to do so, or if the corporation no longer meets the requirements for S status. Termination of the tax election does not terminate the corporate structure. However, the corporation becomes subject to federal corporate income tax in the same manner and extent as if the corporation did not make an election.

An election by the shareholders does not change the character of the corporation income. The corporation still earns income. When the corporation carries on a trade or business, the individual shareholder will never have net earnings from self-employment from that trade or business. However, the shareholder may be subject to employment taxes on reasonable compensation the shareholder receives from the corporation. Sometimes the shareholders may receive dividend payments on their investments. Dividends paid on capital investments are not earnings from self-employment.

Questions may arise in connection with claims involving individuals who are shareholders in this type of corporation relating to the bona fides of the corporate entity and its operation. In general, the approach set forth above applies in resolving such questions. An election not to be subject to corporate taxes is not adequate grounds for questioning the bona fides.

G. Relationship of federal law to local law

We will make determinations about the status of an organization where a question is raised and this determination affects an individual's status under the Social Security Act. It is immaterial if, under state law, the organization is treated as another type of entity. However, local law governs in determining if the legal relationships established in the formation of an organization are such that the above criteria are met. Therefore, local law determines the legal relationships of the members of the organization among themselves, with the public at large, and the interests of the members of the organization in its assets.

H. References

• IRS Publication 542, Corporations

• Social Security Handbook, Chapter 825 What is a Corporation

• Social Security Handbook, Chapter 1109 Families and Partnerships

• Social Security Handbook, Chapter 1110 What Factors Indicate a Valid Partnership

• Social Security Handbook, Chapter 1111 Does Transfer of Capital Interest to a Family Member Make the Member a Partner