No Tax Court for Reasonable Compensation Re-Characterization

By Paul S. Hamann & Jack Salewski, CPA, CGMA

In a recent memorandum to its agents and examiners, the IRS lays out steps to keep Reasonable Compensation challenges out of Tax Court.  Great, you say, nobody wants to go to court!

Not so fast. The option of filing a petition in Tax Court provides taxpayers with time and leverage. By following the steps in this memo, IRS examiners can prevent taxpayers who cannot reach a resolution on a Reasonable Compensating from filing a petition in Tax Court.  This means:

  1. Tax must be paid now. When filing a petition with the Tax Court, taxpayer can avoid paying the tax until the matter is finally resolved.
  2. Leverage Lost. Filing or even the threat of filing a petition with the Tax Court can give taxpayers and their advocates’ leverage to get the appeals agent to settle the dispute favorably.

Since 2005, when the IRS began studying the issue of compliance and Reasonable Compensation for S Corps, the agency has been regularly and consistently improving enforcement and compliance strategies. This relatively unknown memo, prepared by Janine Cook, Deputy Associate Chief Counsel (Exempt Organizations/Employment Tax/Government Entities) to Barbara Wulf, Program Manager (Specialty Exam Policy & Quality, ET policy), is another example of their continued efforts to do just that.

The easiest, best and most cost-effective means for S Corps to avoid this kind of snarl is to avoid the challenge in the first place by doing a competent Reasonable Compensation Analysis, using RCReports or some other means. But if one of your S Corp clients gets in hot water for not doing so or in spite of doing so, here’s what they need to know.

Examiners and appeals agents are advised to take two steps to keep the dispute out of tax court:

  1. Confirm the taxpayer agrees that the corporate officer(s) are employees under Section 3121(d)(1). Do not send taxpayer Letter 3523: Notice of Determination of Worker Classification (NDWC).
  2. Confirm the taxpayer does not claim that they are entitled to relief under Section 530 of the Revenue Act of 1978.

The Tax Court has been consistently dismissing cases that meet the above two criteria for lack of jurisdiction because it does not have jurisdiction when the issue at hand is a re-characterization of distributions when the worker classification of the shareholder as an employee is agreed upon.

So what does all this mean in plain English? It means if there is no disagreement regarding the status of the shareholder being an employee, (rather than an independent contractor for example) then there is no need for the examiner or appeals agent to send out Letter 3523.

Does this mean that shareholder employees should consider paying themselves as an independent contractor via 1099? Absolutely not. This has the potential to get your client in even hotter water. The IRS is very clear and has been very consistent regarding the classification of a shareholder who performs services for the corporation as an employee.

We will follow up next month with an in-depth look at the W-2 verses 1099 question. In the meantime, keep advising your clients to do a Reasonable Compensation analysis and keep it up to date.


RCReports Releases New Tools + Security Upgrade

Denver/Colorado/September 01, 2017

RCReports recently completed a security upgrade to its cloud based software and released two new user tools: An Entity Planner and Preparer Penalty Check List.  In addition RCReports completed a change to the client interface that promotes the user’s practice while masking RCReports software from the client.

“Some of these features were not scheduled for release until our next big upgrade later this year; since they were ready to go, we wanted our users to have the benefits of the upgrades as soon as possible.” stated Paul S. Hamann, President of RCReports, Inc. “We are also excited about the release of version 4.0 of our software later this year.  It will include an expansion of our methodologies and data set, firmly establishing RCReports as the leader in determining Reasonable Compensation for closely-held business owners.”

RCReports is cloud software that determines Reasonable Compensation for Closely-Held Business Owners.  RCReports is used by CPA’s, Tax Advisors, Valuators and Forensic Accountants when they need to determine a Reasonable Compensation figure for a client. Whether it’s for Compliance, Normalization or Planning, RCReports has a report to fit your need.


Jingle Writer

To be in the top echelon of this occupation, jingle writers must highlight the selling points of a product in a way that will make customers really want to buy it. Writing a short song that draws interest and revenue is something of an art. When we think of these classics, we wonder if their writers were in the top echelon: the Meow Mix jingle “Meow Meow Meow Meow…” or Speed Stick jingle “By Mennen”. This month we take a look at what the top 10% in this rarefied profession make:

  • United States ~ 90thpercentile – $52.02/hr
  • North Carolina ~ 90thpercentile – $46.75/hr*
  • Maine ~ 90thpercentile – $35.24/hr*
  • Dallas, TX ~ 90thpercentile – $39.54/hr*
  • Tucson, AZ ~ 90thpercentile – $70.49/hr*

~Each month we highlight an occupation from the more than 6,000 occupations included within the RCReports proprietary database of wages~ *Wage only available from RCReports*