Reasonable Compensation Planning Season Part I: Profitable S & C Corps

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Third quarter already – are you kidding me.  This year, like most, has zipped by.  Soon the last tax deadline will have come and gone, and “Planning Season” will start.  There are two groups of small business clients you should start checking in with as early in planning season as possible to discuss Reasonable Compensation.  They are:

  1. Profitable S Corp & C Corps (Part I)
  2. Profitable Schedule C Filers, LLC’s & Partnerships (Part II)

Shareholder-employees of S Corp and C Corps are required to pay themselves Reasonable Compensation for the services they provide to their company.  Because S Corps are much more prevalent than C Corps as a choice of entity for small business incorporation, this article will focus mainly on the S Corp.  The earlier you begin conversations, the easier it will be to make payroll adjustments before the end of the year.

A fantastic way to get the ball rolling is to send out an issue letter on the subject of Reasonable Compensation informing your clients about the IRS requirements for paying Reasonable Compensation.  The issue letter should explain Reasonable Compensation in plain everyday terms and outline the reasons it is important to research and document Reasonable Compensation each year.  Follow up the issue letter with similar language in your annual engagement letter and include the option (or requirement, depending on your firms’ policy) of running a Reasonable Compensation Report.

After completing a Reasonable Compensation Report for each client, gather the corporation’s anticipated distribution figure for 2015.  Use the Reasonable Compensation Reports interview to make the next step of planning seamless.  For clients who are making no or small distributions keep in mind this IRS Guideline: The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly.  (see also Profitability v. Distributions).

It is a luxury to have time during planning season to consult with your clients, reaffirm their goals as it pertains to distributions, retirement contributions, the return of basis, and repayment of shareholder loans.  Knowing each client’s Reasonable Compensation figure will facilitate these conversations and provide plenty of time to make needed adjustments.

Additional consulting opportunities usually bubble to the surface at this time.  Because determining Reasonable Compensation includes a thorough accounting of all the services shareholder-employees provide their company, it’s a prime time to discuss their best use of time and resources, followed by an opportunity for you to offer additional services such as part-time CFO/CEO, strategic planning, payroll and bookkeeping services.

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