The National Defense Authorization Act of 2013 requires the Comptroller General to report on the effect of reducing the allowable costs of contractor compensation to be equivalent to the compensation of the president or vice president of the United States. If the Comptroller General recommends this reduction, it could cause problems for Subchapter S Corporation owners and officers.

Under current IRS rules, the owner of an S Corporation does not pay payroll taxes on distributions of earnings and profits. In the past, this allowed S Corporation owners to pay themselves very small salaries and instead pay their income in the form of distributions to avoid payroll taxes. To combat this, the IRS recently stepped up enforcement of this issue and audited thousands of S Corporations. The IRS has begun to aggressively assert that S Corporation owners must pay themselves higher salaries so that the earnings of the corporation are subject to the payroll taxes.

However, this will place contractors in a bind if the Comptroller General recommends that allowable salaries be lowered—on one hand, the IRS is telling S Corporation owners that salaries have to be higher, while on the other hand the DOD is pushing the Comptroller General to recommend that S Corporation owners’ salaries above a certain threshold should not be allowed as costs.

The Comptroller General’s report is due in early May, 2013