Reasonable Compensation Risks
Eight of Thirteen Reasons
Why Do Your Reasonable Compensation Analysis, RCASM Plan Every Year?
What Re-Energized “Reasonable Compensation” IRS Audits?
IRS Agents know the median tax adjustment is $105,000 with taxpayer targets easy to find. You can add to that another $20,000 or more in tax attorney and CPA defense costs. You will spend 50 to 100 plus hours, too. Big reasons for you to build your compensation process.
We found that ignoring paying yourself a Reasonable Compensation, RC is the renewed fast track to an IRS audit. The 2017 TCJA adds even more grief.
Are you ready for a IRS business tax audit? We predict 2018 to 2023 to be the biggest years for S Corp IRS audits ever.
For an S corporation,
a. When a shareholder’s compensation is lower than “reasonable”, it violates IRS Codes and brings additional taxes and penalties.
b. If the compensation is higher than reasonable, the shareholder could pay substantial unnecessary taxes, and violate codes.
In a divorce,
a. If the compensation is too high, it understates the company’s value.
b. If the compensation is too low, it understates the company's value, and support and/or alimony.
Internal Promotion and Retention, and Outside Recruiting Plans.
A pay package offer that is “unreasonable” has obvious problems. Making a good salary or wage offer is critical to getting and keeping the right people at a fair price.
Showing a candidate your completed Reasonable Compensation Analysis, RCASM salary or wage calculation gives both you and the candidate two advantages. They know you care by doing your homework; and that the salary or wage offer is reasonable for the position’s job description in the current market.
Business Valuation-Driver Fairness Adjustment.
Valuing a business (or professional practice), compensation should represent the Fair Market Value economics. The adjustment prevents an unjust and misleading business valuation.
Family in the Business.
Paying your family or yourself too much raises an IRS audit flag. Companies with related shareholders and employees rate high on the IRS suspect list.
For a C corporation.
When a shareholder’s compensation is too high, it violates IRS Codes and brings additional taxes and penalties.
Your Reasonable Compensation Analysis, RCASM is a salary or wage calculation that you complete based on your data and choices. Choices the IRS says you must make every year.
The fastest way to kill your financial future is to do something the IRS targets.
The RCASM analytic tool helps set your groundwork. You can build a better way to establish your salary and wages, avoid doing the time-consuming salary or wage research and documentation, and guard against an IRS “Reasonable Compensation” audit. Call 513-266-3226 or e-mail.
The Big Money Risks of Not Setting
The IRS is targeting you, and getting smarter about how they are doing it. Their new task force uses Artificial Intelligence (AI) to audit your business and personal returns. They know you want to game your taxes. They know your tactics. That is how they find that your compensation is not “reasonable” by their definition.
WARNING. The latest data shows the IRS has won 25 cases, and lost only one. Those are costly odds against you. Do not wait for the IRS Notice in the mail.
Salary or wage compensation and distributions are chosen by an owners motivated to reduce payroll and income taxes. Unfairly following that attitude gets you into IRS hot water.
Remember that you are guilty until you prove you are innocent with the IRS. If you cannot refute the IRS claims for tax, penalties, and interest with your records, you can expect more IRS troubles. You need supporting actions taken and facts, not guesses, shown in a proactive process.
Yes, it gets much worse if you just pulled your salary or wage number out of thin air, used ‘artificial safe harbors’ or other ‘rules of thumb.’ However, you knew that.
The Tax Cuts and Jobs Act of 2017 “TCJA” December 22, 2017 has drastic new rules affecting deductions of employee benefits and executive compensation. And, it includes a new 21% excise tax penalty. For-profit, not-for-profit, S Corporations and C Corporations have unique individual hurdles.
In addition, if your salary or wage is off, then your distributions on your K-1 are likely off the mark, and you have a growing problem. So you win the prize, they levy additional tax, penalties, and interest. A surprise bill estimated at double the original tax due.
We will show you that there are many more costly surprise problems.
Contact us, we are an independent, objective third party, who is experienced with reasonable compensation salary and wages analysis. Your salary and wages analysis gives you support for your selected salary and wages for reasonable compensation when challenged by anyone including the IRS and DOL.
Our Cloud Process for Your - Reasonable Compensation Analysis, RCASM
Your Reasonable Compensation Analysis, RCASM is a salary or wage calculation that you complete based on your data and choices. Which report option of several you choose is set when you start and depends on how you will use the report.
Your online interview questionnaire personalizes and fine-tunes your calculation report’s salary or wage factors and issues. Use the follow list to prepare and keep notes of your reasoning for future reference.
- Purpose and Use, outlined above;
- Single or blended multiple job/career categories;
- You should profile the job by making a list of the person’s hours worked or scheduled, and the duties and percentage of time in each category.
1 Maintenance Hours Proficiency Rating
2 Administrative Hours Proficiency Rating
3 Marketing Hours Proficiency Rating
4 Finance Hours Proficiency Rating
5 Human Resources Hours Proficiency Rating
6 Information Tech Hours Proficiency Rating
7 Inventory Hours Proficiency Rating
8 Management Hours Proficiency Rating
9 MY BUSINESS SECTION-Your main work/professional focus, not above.
Examples: Physician, Engineer, Architect, Veterinarian, Analyst, Manager, Construction Trade Specific, Electrician, or Other Careers.
The Proficiency Ratings: Low; Below Avg; Average; Above Avg; High
Proficiency is the individual’s degree of skill, expertise, experience, accomplishment, competence, mastery, professionalism, ability, know-how.
- The candidate’s or staff’s education level, and a rating for competence
- Gather facts for your company’s profile
- and your adjustment amount to the salary or wage calculation for other possible non-salary or non-wage fringe or financial benefits.
You tell us what you what to know. We will tell you how we approach answering. Our data sample pool is statistically broad, deep, stable, clean, and predicable. The data is also geographic location specific.
You control the extent of the project’s included services, and the budget for the services. You determine how you will use the analysis results. You set how far the analysis process will drill down.
Your selections, issues, and provided data determine the project’s fee and the result confidence level to reach your goals. Your invoice lists your specific issues and choices, your fee, our agreement, and is paid by check to David A. Dinsmore before analysis begins.
A Reasonable Compensation Analysis, RCASM salary and wage-planning estimate starts at $100.00 for single defined job description. Your needs may call for a mix of job descriptions to best fit your “Working Title” (see the definition in the Glossary linked at the end of the page) job parameters. Each addition job description blended into the calculation adds $25. Example: Base of $100 plus three additional descriptions, a total of four, would be $175.00.
For Shareholder-Employee IRS Compliance and other more complex goals, projects start at $250.00 and may include analyst interview assistance. Your project’s amount is set before you pay in a FREE 30-minute telephone conference and start the online interview.
The e-mail with your link to the Cloud Interview includes a job description worksheet, and may include supporting information to help you prepare.
How The Treasury Department (IRS) Defines Reasonable Compensation
What's a Reasonable Salary or Wage?
The instructions to the Form 1120S, U.S. Income Tax Return for an S Corporation, state "Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation."
Reasonable compensation. Because an officer of a corporation is generally an employee with wages subject to withholding, corporate officers may question what is considered reasonable compensation for the efforts they contribute to conducting their trade or business. Wages paid to you as an officer of a corporation should generally be commensurate with your duties. Refer to "Employee's Pay, Tests for Deducting Pay" in Publication 535, Business Expenses for more information. IRS
The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly. However, if cash or property or the right to receive cash and property did go the shareholder, a salary amount must be determined and the level of salary must be reasonable and appropriate.
There are no specific guidelines for reasonable compensation in the Code or the Regulations. The various courts that have ruled on this issue have based their determinations on the facts and circumstances of each case.
Internal Revenue Code Section 162 states that to be deductible for federal income tax purposes, executive compensation must be (1) “reasonable in amount” and (2) “based on services actually rendered.”
Treas. Reg. §1.162-7(b)(3) defines “reasonable” compensation as the amount that “would ordinarily be paid for like services by like enterprises under like circumstances."
Reasonable is fair (honest, equitable, even-handed, impartial, free from prejudice, bias, greed, and not self-serving), proper, just, moderate, suit-able under the circumstances. Dictionary
Reasonable compensation is a term used by the IRS to define the compensation amount that is a deductible business expense.
The issue comes up because stockholder-employees can alter their wages and income distributions to avoid taxes. (Comment: This is where costly problems start.)
Under IRC 162 (a), wages are a deductible business expense to the extent wages are reasonable.
In an S Corporation, under-payment of wages occurs in order to maximize pass-through income and avoid payment of FICA and Medicare contributions.
In a C corporation, wages are maximized and dividends eliminated or minimized to avoid the double taxation of dividends. Economic Research Institute, Inc.
Note: IRS Definitions and Rules Change, Check Rules with a Professional Adviser Before Taking And Actions.
Reasonable Compensation Resources
The Replacement Cost Calculation Approach is also known as the “Many Hats Approach.” The analysis interview asks about the many job activities, responsibilities, and career or job categories that many owners carry. The analysis reports lists the job duties selected in the interview for the subject. The job analysis interview requires a judgment on the subject’s job proficiency. The quality of the subject’s work makes a difference in what they are paid.
Glossary of Key Compensation Terms 4
Use the Glossary for clarification of terms. "Working Titles" is one of several need to understand the "Many Hat's" approach taken in the Cost Method of salary or wage determination. The Many Hat's approach adjusts the salary or wage calculation for the range of responsibilities a job may include.
The Standard Occupational Classification (SOC) can help clarify a job reference number, job title, and a brief job description in your evaluation and selection process. You may want to do this even if you are comfortable with your job description. You will use it at each step, and maybe more so in the MY BUSINESS section near the end of the online data entry.