How the IRS Determines Reasonable Compensation using the IRS Job Aid

By Paul S. Hamann & Jack Salewski, CPA, CGMA

Over the last decade, the IRS has steadily and methodically tackled the compliance hassle that is reasonable compensation. According to an exhaustive 2009 GAO Report, S Corps were under-reporting shareholder compensation by more than $23 billion (for tax years 2003-2004) (Ruh-Roh Reorge!)

A few years later the IRS put together a game plan for its staff. This internal “Job Aid” sets out when and how penalties should be assessed and details three approaches for determining reasonable compensation. It also comes with a warning: “This Job Aid is not an official pronouncement of law…” In sports lingo, the courts are still going to referee, but at least now we understand the rules of the game.  We’re no longer playing Calvinball, making it up as we go along (shout out to you Calvin & Hobbes fans!) and that was a huge win for tax preparers and taxpayers.

With the likelihood of increased audit attention on S Corps (more on this next month), moving your approach from myths or guessing to employing a fact-based strategy (as outlined in the IRS Job Aid) will greatly reduce the risk for the preparer (Are You at Risk for Preparer Penalties?) and S Corp that may be relying on myths such as “Rules of Thumb” or “Safe Harbors”.

The three approaches discussed in the Job Aid are: (more…)