By Paul S. Hamann
It is important to talk with your S Corp clients now about their Reasonable Compensation. Most S Corps, whose fiscal year matches the calendar year, must have their payroll completed before year-end. Waiting until next year to address this issue with your clients could cost them big.
If your S Corp clients followed the best Reasonable Compensation strategy, researching and documenting their Reasonable Compensation figure at the beginning of the year, and then paid themselves a regular salary throughout the year, you and your clients can don your New Year’s party hats early, because your year-end planning and adjustment will be minimal.
On the other hand, if your clients have been taking out distributions throughout the year or plan to take a distribution before the end of the year but have paid themselves little or no Reasonable Compensation, you and your clients have some work to do before you can blow noisemakers and throw confetti.
First, your client will need to research and document their Reasonable Compensation figure. Next, you and your client will need to reclassify any distribution already taken or any distribution that will be taken as wages, up to your clients' Reasonable Compensation figure. Make sure the payroll check is processed before the end of the year and that the 4th quarter 941 and annual 940 deposits and returns are completed on time. This is not an ideal strategy because the IRS prefers S Corp owners pay themselves as regularly as possible throughout the year and make regular payroll tax deposits and file quarterly 941s. If your client is in this boat make sure they are filing their quarterly 941s even if there was no payroll, or they could get hit with late fees and penalties for not filing.
Your client doesn’t take any Reasonable Compensation for the services they provided but does take a large distribution. This will probably catch the attention of the IRS, need I say more…
You and your client wait until next year to address Reasonable Compensation. Even if you backdate payroll into 2013 (which you shouldn’t do), your client will likely owe late fees and interest for a late payroll tax deposit.
Your client pays Reasonable Compensation via 1099 instead of W-2. Bad move, because if the IRS looks at this they will most likely require you to reclassify the 1099 payment as wages and file 941s for each quarter. Even though there probably won’t be any significant difference in the actual payroll taxes owed, the late fees, penalty and interest on the missed 941s will be significant. Remember, an S Corp is a business and a business pays employees via payroll, and this includes shareholder-employees.
In a poll conducted by RCReports, CPA’s and Financial Advisors responded that the fastest and easiest way to get their clients to determine their Reasonable Compensation figure was to send their clients a short issue letter, educating them on the issues, and recommending they research and document their Reasonable Compensation figure. If you are looking for a good issue letter to send your clients, you can find one inside your RCReports dashboard.