By Paul S. Hamann & Jack Salewski, CPA, CGMA
Ask yourself a few simple questions:
- Have I educated all my S Corp clients about Reasonable Compensation?
- Is each client's Reasonable Compensation figure, on its face, reasonable based on the client's training, experience, responsibilities and time devoted to the company?
If you answered ‘yes’ to both questions you are probably not at risk for a Preparer Penalty. There are a few more questions you should consider before you know if you are out of the woods. To help evaluate your risk and avoid preparer penalties, please use our complimentary Preparer Penalty Check List and Stress Test.
If you answered ‘no,’ you may be at risk for a Preparer Penalty. We have interviewed preparers who have been assessed $5,000 penalties, and here’s what their experience can teach you:
Because most S Corp owners do not understand Reasonable Compensation, as their tax advisor, the burden of educating them falls on you. The IRS requires tax preparers to be proactive in asking for the right information, even if it means you need to spend more time with the client during the preparation process. Asking the appropriate questions and providing appropriate documentation should keep you out of harm’s way.
The following points are by Larry Jacobson, CPA/JD from an article in the AICPA Tax Preparers Beware.
- …the IRS does expect preparers to have appropriate checklists for different types of clients. The IRS appropriately expects preparers to elicit information from taxpayers that would be reasonably necessary to prepare a tax return.
- …the IRS does not expect the preparer to merely accept the information given to her by the client. Rather, the IRS anticipates the preparer will review the information given by the client, compare that information to a checklist or some other written procedure and ask the client for additional information if necessary for the preparer to complete a professional tax return.
- …the IRS does require the preparer to be proactive in terms of asking for the right information necessary to prepare tax returns, even if it means the preparer will need to spend more time with the client during the preparation process.
- …penalties can and will be imposed on preparers who fail to make reasonable inquiries of their clients during the preparation process.
The best practice for meeting these standards is to require your S Corp clients to provide documentation backing up their Reasonable Compensation figure. However, we live in the real world and know some clients may not take your advice. In this case the Best Practice is to document your attempt/request to have them research and document their Reasonable Compensation figure and keep your documentation with the return.
RCReports can help with both Best Practices. Reasonable Compensation Reports are quick and easy to prepare for your clients and an excellent revenue stream. Free tools such as our downloadable issue letter, engagement letter and printable Reasonable Compensation questionnaire are available to all subscribers and provide tax advisors with some cover when provided to client’s that don’t take their advice.
Three reliable sources have confirmed the IRS will be focusing on S Corp audits beginning this year:
• Forbes: Will There Be A Rise In IRS Audits of S Corporations?
• Michael Gregory, Former IRS Territory Manger: My sources confirm the premise of the Forbes article
• Beanna Whitlock, EA, Former IRS Director: Austin, TX field office graduated 2,500 agents in October 2018 trained on Reasonable Compensation