Reasonable Compensation Risk Assessment

Is your firm at risk if one of your clients undergoes an IRS audit?

Take this short assessment to gauge your firm’s risk today.

    Step 1

    Do you send Issue Letters to your clients (educate your clients about reasonable compensation)?

    Step 2

    Do you run Reasonable Compensation Reports for all of your S-Corp clients?

    Step 3

    Do all of your S-Corp clients provide independent research and documentation to support their reasonable compensation figures?

    Step 4

    Do the majority of your clients' reasonable compensation figures appear to be reasonable based on:

    (A) Training & experience

    (B) Duties & responsibilities

    (C) Time & effort devoted to the business

    (D) Location of the business

    Step 5

    Do your clients make as much, or more, than any non-shareholder employees of the business for performing essentially the same services?

    Step 6

    Do your S-Corp clients pay themselves via W-2?


    Step 7

    Enter your information to receive your score and recommendations for improvement.


    Reasonable Compensation Risk Score

    Risk Index

    Risk Analysis

    0 - 3 Low
    4 - 6 Medium
    7+ High

    Low Risk

    Good news! You’re already doing better than most accounting professionals when it comes to reasonable compensation. It’s always good to be diligent and look for ways to improve – here are a few recommendations to help you ensure your clients are protected.

    Moderate Risk

    Based on your answers, you’re at a moderate risk for losing a reasonable compensation challenge. Here are some tips to help you improve your risk posture and ensure your clients are protected.

    High Risk

    Uh oh! You’re at high risk for losing a reasonable compensation challenge. Don’t worry – we can help! Here are some recommendations to help you improve your risk posture and ensure your clients are protected.

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    Recommendations

    Educate your clients

    Whether via an issue letter, a dedicated section of your engagement letter, or a conversation on the advisory services you offer, make sure your clients fully understand the implications of their reasonable compensation figure.

    When you subscribe to RCReports, you’ll get access to our resource library that includes issue and engagement letter templates, IRS guidelines for reasonable compensation, and information on many court cases surrounding the issue that can be used to help educate your clients.

    Require data for all reasonable compensation figures

    If you sign off on a reasonable compensation figure that the IRS later deems unreasonable, you as the preparer can face penalties and fines! The best way to avoid this is to require independent research and documentation for every client’s reasonable compensation figure and keep that data on file with their tax returns.

    If you use RCReports, you’re already tapping into our independent wage database and receive backup for every report you run. Plus, our reports have been battle tested in IRS audits (and never lost)!

    Use the right approach to determine reasonable compensation

    There are three generally accepted approaches to determining reasonable compensation – the Cost Approach, Market Approach, and Income Approach. The Cost Approach and Market Approach are by far the most common methods used with the Income Approach reserved for outliers. 

    It’s important that you as the advisor understand each approach and when to use them. Here’s a great article that explains each approach in detail.

    RCReports offers all three of these approaches in our easy-to-use software. Each approach comes with a full report that backs up the number generated.

    Stress test the reasonable compensation figure

    Even if you use a tool such as RCReports, it’s always good to do a quick stress test against the figure that is provided as you know your client best. You may need to recommend an adjustment to the figure based on different factors such as your client’s education and experience levels or the number of hours they work in the business.

    If an adjustment is recommended, you can use the Pro Advisor Worksheet to fine tune the reasonable compensation figure and amend the report provided by RCReports.

    Do a quick internal check

    Owners should be paid roughly the same amount for performing essentially the same services as non-shareholder employees.

    Require S Corp clients to pay themselves via W-2: It’s the law!

    All shareholder employees must take reasonable compensation before they can take any distributions from the business. Their reasonable compensation must be paid via W-2 and is subject to normal payroll taxes.

    Skipping a W-2 can be expensive if the IRS gets finicky and requires you to go back and amend prior years wage reporting.

    If there’s debate about what their reasonable compensation figure should be – run a report in RCReports! That will give you and your client a number backed by independent data and research that will hold up in IRS audit.

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