Blog
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What You Need to Win an IRS Reasonable Compensation Challenge
- May 1, 2022
- Posted by: Paul Hamann
- Category: Blog
By Paul S. Hamann & Jack Salewski, CPA, CGMA
This is a true story. Names & identifying details have been changed to protect the innocent.
Nancy had a feeling that $40,500 was a good Reasonable Compensation figure for her as owner of Nancy’s Nail Salon. She didn’t have any facts or data to back it up, but she wasn’t trying to get away with anything either. Her accountant thought it felt right, too. Who would check, anyway? Nancy just wanted to get back to the salon and keep making money. Her accountant jotted down $40,500 and reported that to the IRS.
Turns out Nancy’s feeling was correct.
But being correct didn’t save her from months of stress when the IRS came after her. Being correct didn’t save her from expensive accountant fees. And for months she was distracted from the business she loved. (more…)
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IRS lays out steps to keep Reasonable Comp challenges out of Tax Court
- April 1, 2022
- Posted by: RCR Admin Team
- Category: Blog
By Paul S. Hamann & Jack Salewski, CPA, CGMA
In a 2017 memorandum to its examiners and appeals agents, the IRS lays out steps to keep Reasonable Compensation challenges out of Tax Court. Great, you say, nobody wants to go to court!
Not so fast. The option of filing a petition in Tax Court provides taxpayers with time and leverage. By following the steps in this memo, IRS examiners can prevent taxpayers who cannot reach a resolution on Reasonable Compensation from filing a petition in Tax Court. This means:
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- Tax must be paid now. When filing a petition with the Tax Court, taxpayer can avoid paying the tax until the matter is finally resolved.
- Leverage Lost. Filing or even the threat of filing a petition with the Tax Court can give taxpayers and their advocates’ leverage to get the appeals agent to settle the dispute favorably.
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How to Stress Test a Reasonable Compensation Figure
- March 1, 2022
- Posted by: RCR Admin Team
- Category: Blog
Stress testing a reasonable compensation figure is simple. The courts have listed the factors they consider when determining whether a reasonable compensation figure is indeed reasonable. We can use those factors to “stress test” any reasonable compensation figure. (more…)
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What if an S Corp Owner can’t afford to pay Reasonable Compensation?
- February 1, 2022
- Posted by: RCR Admin Team
- Category: Blog
By Paul S. Hamann & Jack Salewski, CPA, CGMA
This is by far the number one question we receive, and the answer is both simple and complex. Why? Because the amount of Reasonable Compensation actually paid is tied to distributions, not profit or loss.
Depending on the company’s financial condition and business strategy, a shareholder-employee may be able to take Reasonable Compensation plus a distribution, just Reasonable Compensation, or neither. What the shareholder-employee can’t do is take a distribution instead of Reasonable Compensation.
To help you better understand, let’s run through a few simple scenarios and then move onto some more advanced ones. Keep in mind the following:
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W-2 or 1099 for Shareholder-Employees of S Corps?
- January 1, 2022
- Posted by: RCR Admin Team
- Category: Blog
By Paul S. Hamann & Jack Salewski, CPA, CGMA
1099 or W-2? That’s the number one question Jack receives here at RCReports.
Answer: W-2
We hear your argument: Paying wages via 1099-MISC instead of W-2 has no tax effect!
Here’s Jack’s reply: It’s the law.
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How one Reasonable Compensation Report saved a Taxpayer $80,000+
- December 1, 2021
- Posted by: Paul Hamann
- Category: Blog
By Paul S. Hamann & Jack Salewski, CPA, CGMA
Is credible data really that important? Yes. In one recent case, data convinced an IRS Examiner to abandon an unreasonable position, saving the taxpayer thousands of dollars. In the process, the CPA, whose data-less compensation guess attracted the audit in the first place, saw his reputation tarnished. But the reputation of the taxpayer’s data-driven CPA rescuer is looking even brighter. (more…)
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77% of Accountants Misinformed on Reasonable Compensation
- November 1, 2021
- Posted by: Paul Hamann
- Category: Blog
By Paul S. Hamann & Jack Salewski, CPA, CGMA
The most popular methods for computing reasonable compensation are, like the cool kids in high school, cute and fun to hang around with, but not who you need at your side come finals week. Conventional Wisdom, Rule of Thumb, and Safe Harbor methodologies win the popularity contest among accountants, but all three get an “F” in front of tax court judges.
We recently polled 4,541 CPAs, EA’s, and other tax professionals. Here’s what we asked: Which of the following methods of determining reasonable compensation are recognized by the IRS? (more…)
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“More Action Can Be Taken”: IRS Aims Big Data at Officer Compensation
- October 1, 2021
- Posted by: Paul Hamann
- Category: Blog
By Paul S. Hamann & Jack Salewski, CPA, CGMA
Just how big of an issue is S Corp. officer compensation under-reporting? Big would be an understatement. The most recent estimate (TY 2011-2013) has S Corp. owners underreporting compensation by $24 billion per year, twice as much as ten years earlier.
So, what is the IRS doing about it? (more…)
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BLOSSOM DAY CARE v. IRS Tests 20-Year-Old Precedent
- September 1, 2021
- Posted by: Paul Hamann
- Category: Blog
By Paul S. Hamann & Jack Salewski, CPA, CGMA
“Too clever is dumb” quipped the humorous poet Ogden Nash. He wasn’t wrong. A couple of named Hacker found that out the hard way, and by that we mean the expensive way.
It has been about seven or eight years since we last had an S Corp Reasonable Compensation challenge come out of the tax courts. In the author’s humble opinion, that’s because there is very little left for taxpayers to test out in court. Most issues have already come up. Precedents have been established.
That didn’t stop the owners of Blossom Day Care (Barry Hacker and Celeste Hacker – The Hackers) from spending a decade and (likely) tens of thousands of dollars trying to subvert Revenue Ruling 74-44 and a 20-year-old plus precedent that classifies corporate officers as employees. (more…)
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Fact or Fiction – How are you advising your clients?
- August 1, 2021
- Posted by: Paul Hamann
- Category: Blog
By Paul S. Hamann & Jack Salewski, CPA, CGMA
We recently polled 993 CPAs, EA’s, and other tax professionals to find out if they could recognize fact from fiction as it applies to the IRS’s guidance on how to determine reasonable compensation. 81% believed the fiction.
Here’s what we asked: Which of the following methods of determining reasonable compensation are recognized by the IRS?
A. Industry Rule (Set wages as a percentage of sales or revenue based on industry standards)
B. 50/50 Rule (50% distribution – 50% Wages)
C. Safe Harbor Rule (Set wages at the S.S. Max)
D. All the above
E. None of the above
81% selected A, B, C, or D – all of which are myths. Congratulations to the 19% who got it right.
So, what gives? Why do so many accountants believe these myths are “rules”? (more…)