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Three Methods of Determining Reasonable Compensation Part I: The Cost Approach

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

There are three generally accepted methods for determining reasonable compensation for the owner of a closely-held business. It is important to match each method with the business's size and business owner’s job duties.

  1. The Cost approach, aka many hats, approach: Generally works best for small businesses where the owner wears multiple hats.
  2. The Market approach, aka the industry comparison approach: Generally works best for SMB’swhere the owner performs predominantly managerial tasks.
  3. The Income approach, aka the independent investors' test: Generally works best for outliers.

 

The Relationship Between Business Valuation and Reasonable Compensation

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

A common question in public practice is, “how much is my business worth?” This question comes up for a variety of reasons. It could be a business merger, sale of the business, divorce, death or even idle curiosity.

There are a lot of different factors that go into a business valuation. It is an oversimplification, but most businesses are valued as a multiplier of earnings before interest, taxes, depreciation, and amortization (EBITDA).

When more wages are taken out than what is reasonable, the value of the business will be understated. This will cause the company and the shareholders to pay more in payroll taxes than they should. If less wages are paid out than what is reasonable, then the company value will be overstated.

How an S Corp can Lose Money AND be Required to Pay Reasonable Compensation

By Paul S. Hamann & Jack Salewski, CPA, CGMA (From our Archives)

This scenario is possible because Reasonable Compensation is not tied to Profit or Loss but to Distributions.   The IRS guidelines for Reasonable Compensation state: The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly.  It does not mention profit or loss at all but instead talks about ‘amounts received’ by the shareholder.  Therefore it does not matter whether or not the company is making or losing money; what matters is whether or not the S Corp owner is taking money (or other items of value) out of the S Corp.

Reasonable Compensation Past, Present & Future

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

It doesn’t seem that long ago that the best advice for determining reasonable compensation was a rule of thumb or safe harbor figure; boy, have things changed. Beginning in 2005 the IRS launched a study of S Corp compliance. Since launching this study the IRS has

Reasonable Compensation Year End Check List

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

I am not a big fan of checklists or New Year’s resolutions, but – there’s always a but –that being said, they are helpful in an annoying sort of way. So, in an attempt to use a checklist and New Year’s resolution for good I have put together a short but important to-do list for you and your clients, so you can move Reasonable Compensation from the Procrastination column to the Done column.

A Sincere Thank You to all who answered my “Quick Question”!

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

Since we released RCReports V1 almost five years ago I have asked users WHY? Why did you register? Why did you subscribe? Why did you renew?

The answers have helped us better understand how RCReports was being used, where it was helpful, and where it needed improvement.

Reasonable Compensation and the Single Shareholder S Corp

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

“If there is only one shareholder and no other employees, should all distributions be taken out as Reasonable Compensation?”

This is a common question we receive at RCReports and like with most of the questions we receive, the answer is: “Maybe.”

If the business is so unique or the services of the shareholder are so unique, that no one could be hired to replace the owner and there are no other assets in the corporation, then everything taken out of the business should be treated as wages (Reasonable Compensation) and nothing should be considered a distribution.

Using Corporate Minutes to Protect Against a Reasonable Compensation Challenge

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

We regularly emphasize how important it is to have your S Corp clients who perform services for their S Corp research and document their Reasonable Compensation as a strategy for warding off an IRS Reasonable Compensation challenge.

But what about protecting the shareholders who don’t perform services, especially if they’re listed as an officer of the corporation.

Three steps to Reasonable Compensation compliance for all of your S Corps

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

"The only reason for time is so that everything doesn’t happen at once.” Albert Einstein

Use time to your advantage! Here’s how one RCReports subscriber brought every S Corp he worked with into Reasonable Compensation compliance in three easy steps. (Full disclosure: The steps below assume you have an RCReports account.)

Reasonable Compensation and Multiple S Corps

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

There are numerous issues when a business owner is a shareholder in more than one S Corp. Does the shareholder have to complete a reasonable compensation assessment (RCA) for each corporation, or will one assessment do? Does each corporation need to pay wages? What happens if the owner is above the Social Security maximum?

Why Add Reasonable Compensation to your Practice?

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

There are more answers than you think.  Certainly, you want to research and document your S Corp client’s reasonable compensation figure or help them choose the best entity for their situation.  But even more importantly – it builds a closer relationship with your client, enhancing your ability to become a trusted advisor, the person your clients turn to first – because you know them best.

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