With the September and October tax deadlines behind us it’s time to think ahead to the next tax filing season which is really only a few weeks away! As we have all been watching, the IRS is amping up its enforcement of tax laws, specifically those aimed at high net worth business owners. These are likely to increase over the next few months. This is certainly going to result in some red flags for audits as you begin year end tax planning.
However, while it is critical to look at any potential audit triggers as red flags, I think there’s an immense, untapped opportunity to look at the potential of your clients tax situation for a number of advisory opportunities which can not only create more value for them, but more revenue for your firm, too.
Consider these potential IRS audit scenarios, each of which creates a valuable advisory opportunity:
1. S-corp and reasonable compensation analysis (especially for LLC owners who need to switch). This move is, as you likely know, one of the keys to reducing taxes and making sure that the client is paying themselves an appropriate salary based on the functions they actually perform in their business.
2. New entity selection through proper entity planning. Helping your clients understand when it is the right time to change their entity type can save them thousands. This is an easy win for you to offer data-based analysis and calculations that support making a move to a different entity type.
3. Payroll tax audits tied to reasonable compensation. These audits are a sleeping tiger when it comes to IRS enforcement. It is becoming more common to see payroll tax audits coming up tied to reasonable compensation and other tax issues for owners of any size business.
I have heard of cases involving clients who are being audited for multiple years of payroll taxes stemming from one incorrect reasonable compensation calculation. Helping our clients avoid situations like these is yet another instance where we can shine as proactive partners for our clients!
4. Employee Retention Credit (ERC) audits paired with s-corp reasonable compensation audits. Now that the IRS has officially put the kibosh on any new ERC claims through at least December 31, 2023, (due to growing concerns about widespread ineligible claims), it is not a stretch to anticipate that the number of ERC audits will increase. When checking an employer’s eligibility for ERC, the IRS will determine if the employer paid W-2 wages during the eligibility period. Since S-Corp owners are paid via W-2, this could make them vulnerable to an additional reasonable compensation challenge.
5. 941 audits that lead to reasonable compensation audits. In this case, the IRS is looking at not only reasonable compensation but also to see if 1099 contractors should actually be employees. The amount of the payments being made to contractors will also be scrutinized. It is imperative for your clients to file these returns and to make sure that they file them with accurate withholdings.
The auditor can go, oh, by the way I see you set your reasonable comp as xyz. That seems low so I’m going to add on a reasonable comp challenge. This resource can help.
You may have noticed a common theme running through many of these potential audit scenarios: reasonable compensation of the business owner which then leads to a cascade of other audit triggers and exposure for s-corps and other entity-type owners. This underlines the danger of the “set it and forget it” philosophy of many tax practitioners and their clients when it comes to reasonable compensation.
If you cannot document the number your client is claiming for reasonable compensation (and you don’t have any real data to back it up), you could potentially be on the wrong side of an IRS reasonable compensation challenge. This is not where you want you or your client to be.
The good news is, being proactive with your tax clients, and leveraging technology for more efficiency (and proactive protection) during tax season will help you identify and head off potential audit issues. Ready to make a plan for addressing these and other strategies ahead of tax season?
Book a 30-minute demo to learn how RCReports can save you from living a horror story.