Reasonable Compensation
Risk Assessment

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.