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Reasonable Compensation Reporting: Part 1
March 29, 2023 •TaxPlanIQ Support team
Jackie recently met with Paul Hamann of RCReports to discuss their partnership with TaxPlanIQ.
Paul has specialized in reasonable compensation for small businesses for nearly a decade. He plans to use his time today to explain how this concept relates to s-corps and how RCReports can be a valuable tool for tax advisors.
He’ll focus on s-corps instead of c-corps because, while it can affect them, it’s typically not as large of an issue for c-corps.
As a side note: you can learn more about reasonable comp in TaxPlanIQ under the “strategy” tab and clicking on
Ideally, the goal is to get reasonable comp as low as you legally can because you want to minimize FICA, payroll taxes, and self-employment taxes. You also have to ensure you are following the IRS guidelines on top of this. Considering it’s tough to find this number, Paul and his team at RC Reports created software to calculate your reasonable comp and create a report that can be used for backup if you’re audited.
Let’s take a closer look at RC Reports.
Paul says IRS audits have been up and down in reference to reasonable comps over the last 10 years, but in the last two, there’s been a steady rise. This rise can be partially contributed to a new compliance initiative that was launched in 2020. They plan to keep going after s-corps for reasonable comp because it’s a common compliance issue with larger budgets and new agents.
The RCReports software brings two things to the table when adhering to reasonable comp.
- The system was built around IRS guidelines and their job aid on how to calculate reasonable compensation.
- RC Reports is an independent unbiased source, well-known and respected by the IRS.
While businesses that use RCReports are not immune to audits, Paul says if you run their reports proactively, and the IRS comes, the examiners typically check it off their list and move on. This is because they know their reports are built on their guidelines.
Since reasonable comp has been around for a while but hasn’t been taken seriously until recently, tax advisors have begun to see the rules of thumb to be actual rules, but they are not. RCReports spends a lot of time helping advisors realize the myths and the facts so they can come up with the right figure.
If you are not proactive, the reports become a middleman to justify the numbers and serve as a tax resolution.
Jackie’s Personal Experience
Jackie used RCReports when she first started her firm. Before running the report, she expected the reasonable comp to show closer to $80,000, instead, the report showed the number to be closer to $30,000. This is because they take a different approach to calculating time, admin tasks, and things of that nature.
Three Reasonable Comp Reporting Methods
There are three common reporting methods for reasonable comp.
The first is the cost approach. This is also known as the many hats approach. It’s IRS approved and is the most popular among small businesses.
The second is the market approach, also known as the industry comparison approach. This is for larger companies and business owners who are in management positions.
Last is the income approach which is rarely used. When it is, it’s typically for litigation purposes.
How Do Reasonable Comp Reports Help the Taxpayer?
Let's say you think to pay yourself $80,000 but reasonably (after running the reports) could pay $30,000. This means you’re costing yourself $50,000 worth of payroll taxes, which is roughly $7,650 each year.
It’s most beneficial to run the report recurringly. At least once per year is a good insurance policy. Paul suggests running it in the fourth quarter to look at what you’ve been doing throughout the year and make adjustments to get your reasonable comp on target by the end of the year.
He also recommends running it again sometime after tax season.
Has anything changed work-wise?
How is that going through payroll?
Wages are continuously updated so this is a good check-in point.
TIP: The IRS cannot enforce reasonable comp or W2 wages if the owner is not taking money out of the company.
Considering reasonable comp is tied to distributions, you must pay it before taking a distribution.
Let’s look at an example.
Say your reasonable comp is $80,000 but you’re only taking $50,000. You’ll need to take the entire $50,000 in reasonable comp. If your reasonable comp is $80,000 and you’re taking $100,000, then you’ll take $80,000 as reasonable comp and $20,000 in distribution.
This is why it’s so important to run these reports. Reasonable comp matters.
More Information on RC Reports
For more information about reasonable comp and RCReports, go to the “Education” page on their website.
This article just covers the first half of our conversation with Paul. In the next article, we’ll cover the risks associated with reasonable comp, steps the accountant needs to walk through, and a case study example. We’ll see you there!