By Paul S. Hamann& Jack Salewski, CPA, CGMA
A small business owner I know jokes that his business card should read “President and Janitor” (and everything in between). So, when my friend tries to determine his reasonable compensation figure (at his accountant’s request), should he be compensated as President? Janitor? Or somewhere in between? Where in between?
That’s the challenge faced by S Corp owners when trying to determine their Reasonable Compensation figure. The IRS guidelines for determining reasonable compensation specifically state that “In addition to the shareholder-employee direct generation of gross receipts, the shareholder-employee should also be compensated for administrative work performed…” In other words, the IRS wants the S Corp owners to pay themselves appropriately for all the duties and responsibilities they provide to their company.
Why is this question so difficult to answer? Because no two small business owners do the same things for their S Corps. Therefore, to get an accurate reasonable compensation figure an S Corp owner requires a unique, custom job profile. Building a custom job profile is a daunting, time-consuming process, which is probably the reason most S Corp owners don’t do it.
Would more small business owners make one if it were easy and quick? Of course, they would. In roughly 20 minutes RCReports can build a custom job profile for a small business owner and calculate an annual salary to match. (Click here to learn more about RCReports)
Or for the do-it-yourself crowd follow these steps:
- Make a complete list of all the services you provide to your S Corp
- Apportion your time among all the services listed
- Rate your level of expertise and experience for each service performed
- Gather wage data on all the services listed and at the appropriate level of expertise
- Assemble all your research and data and calculate your Reasonable Compensation figure
Keep in mind that determining a Reasonable Compensation figure is far from an exact science. It is important that you research and document how you determined your Reasonable Compensation figure, and keep your explanation and all back-up documents and reference sources in a place where you can find them when the IRS comes calling. If the IRS challenges your number, you will need a detailed explanation on how you came up with your Reasonable Compensation figure.
Preparer Penalties & Reasonable Compensation
Because the majority of S Corp owners do not understand Reasonable Compensation, the burden of educating them falls on their Tax Advisor. The IRS requires tax preparers to be proactive in 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. Asking the appropriate questions will keep the preparer out of the penalty box. AICPA Tax Preparers Beware
RCReports has the most complete set of wage data anywhere because of our Statisticians. We have wages for every occupation, in every location, in 5 proficiency levels, nationwide. Our process and algorithms are so unique they are being patented.
RCReports just expanded its wage database to 5 proficiency levels. Below is a look at all 5 proficiency levels for statisticians in Castle Rock, Colorado:
- Poor $24.13 per hour
- Below Average $29.53 per hour
- Average $36.70 per hour
- Above Average $44.65 per hour
- Excellent $51.33 per hour