I focus my practice on tax resolution, representing taxpayers in Colorado, Florida, and across the United States.
If you are an S corp owner, I need to alert you to new risks related to the accuracy of your Reasonable Compensation figure. (Just as a refresher, “Reasonable” Compensation is the salary or wage that you, a greater than 2% shareholder-employee of an S Corp, must pay yourself for the work you perform for your company). The IRS is focusing on S corporations where distributions are made without the proper reasonable compensation being taken. This can lead to reclassified wages, and significant additional payroll taxes and penalties being assessed.
There has been a lot of information in the news regarding the IRS being funded (outlined in the recent IRA22 “INFLATION REDUCTION ACT” legislation). One of the key takeaways is clear - the IRS intends to audit S-corporations at a much higher rate in the near future, specifically focusing on Reasonable Compensation. In fact, WE have been through two Reasonable Comp audits already this year – during tax season no less.
Most business owners aren’t aware of this, but the penalties for taking low, or no, Reasonable Compensation are steep for both you as the S-Corp owner and for me, the practitioner. The IRS can, and will, hold tax preparers responsible for reporting unreasonable compensation on their clients’ 1120S tax return, assessing preparer penalties of up to $5,000 for signing off on an unreasonably high/low compensation figure.
The following actions are needed to determine reasonable compensation:
- Use an IRS approved method
- Use an unbiased, verifiable source of data
- Keep detailed records of how we arrived at your figure & data sources used
In the past, this would have taken hours to compile to get remotely close to an accurate figure. The great news is, we now have the ability to produce a personalized Reasonable Compensation Analysis report that, to date, has been bulletproof and undefeated against every single IRS audit. Because of annual compensation and industry changes, a Reasonable Compensation Analysis report is required every year. This report helped our most recent client, subjected to a Reasonable Comp audit, avoid paying over $30,000 in back taxes. If he did not have this report (and knowledge that he could actually fight this audit), he would have wound up paying the entire $40,000. Based on recent audits, it looks like the IRS is going back to 2022 as a starting point.
In addition to protecting yourself if you are audited, this report also gives you these added benefits:
- Reduce Tax Burden: Taking the correct payroll so you don’t under/over pay payroll taxes and get caught shorthanded if audited
- Maximizes Retirement Contributions: A reasonable salary allows you to contribute more to retirement plans like SEP IRAs or Solo 401(k)s, significantly boosting your retirement savings
- Avoids IRS Penalties: The IRS closely scrutinizes S corporations to ensure reasonable compensation is paid. If your salary is too low compared to your job duties and industry standards, the IRS can reclassify some or all of your S Corp distributions as wages, leading to significant tax penalties and back taxes
- Loan Applications: When applying for a business loan, lenders consider your S Corp salary as part of your financial picture. A reasonable salary demonstrates financial stability and increases your chances of loan approval
To learn more about protecting yourself against the IRS, schedule a brief 15-minute call with me by clicking on this link: https://calendly.com/mmoran-6/reasonable-compensation-call
Michael Moran, CEO, EA
Apex Tax Defense LLC
844.545.5829
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