The Year In Review: 2013 brought us some great insight into the field of Reasonable Compensation by way of the McAlary case.
Compensation Agreements – McAlary had a Compensation Agreement, but the courts didn’t buy it: “We are not persuaded that the remuneration agreement represents a sound measure of the value of the services that Mr. McAlary provided to petitioner during 2006. We cast a sceptical eye on the agreement inasmuch as Mr. McAlary sat on both sides of the table when the agreement was executed, occupying the positions of both employer and employee. The agreement clearly was not the product of an arms-length negotiation.”
Take Away – Even though compensation agreements are 1 of 9 factors the courts will consider when determining Reasonable Compensation they need to be reasonable, represent real value, and be negotiated between disinterested parties.
2,080 – This is the magic number for multiplying an hourly wage to get an annual salary. The Bureau of Labor Statistics defines “year-round, full-time” employment as 2,080 hours per year (40 hours per week). Both the IRS expert and the courts used this number to determine McAlary’s Reasonable Compensation figure from an hourly wage figure, even though McAlary regularly worked 12 hours days and six to seven days a week.
Take Away – This is one of the few pieces of guidance the courts and the IRS have given us that actually makes things clearer and simpler. (RCReports has always used 2,080 as full-time year-round employment in its algorithms.)
The Year Ahead: 2014 looks like a year that we will see another increase in S Corp audits.
- The number of S corporation tax returns examined has increased more than 30 percent over the past five years, and more than 33 percent in the last two years.
- In response to a recent government report, the IRS will be improving its procedure for determining and enforcing penalties on paid tax preparers.
- Faris Fink, the commissioner in charge of the IRS’s Small Business/Self-Employed Division told attendees that his unit would make auditing the tax returns of partnerships and other pass-through entities a top priority. Part of that strategy will involve training agents at the IRS to look more closely at S corporations…