Reasonable compensation

[S&D Associates]

in order to arrive at reasonable compensation for a single member Tax preparation S-Corp shareholder, would using the hourly salary of a hired tax preparer and a office manager be a reasonable formula? Any suggestions would be appreciated?

[spanel]

Are you the only employee? What is your role for the Corp?

Chris

[kathyc2]

Reasonable comp is subjective and many people here have differing opinions. I try to look at what generates profits; two main ones being investment in equipment/inventory, and labor.

Generally, service businesses to not have a large investment in equipment or inventory, so little if any profits allocated to the effect these have on profits.

Next is labor. If the labor is supplied solely by the owner/shareholder, then the vast majority of profits should be allocated to reasonable comp. If labor is also provided by non-shareholder employees, then a portion of the profits generated by them cam reasonably bypass reasonable comp IMO.

[AZUKHiker]

I agree with Katthyc2's comments.

Also I ask the client what would you need to pay somebody to do your job. That is going to include an assessment of the skill set required and the labor cost of just running/organizing the business.

[TaxGuyBill]

Another agreement with Kathy.

In my opinion, if sole employee/shareholder does all of the work and has minimal financial investment, then almost 100% of the profit should be wages. The more that other people do the work and/or the employee/shareholder had large financial investments into the business, the more that can be allocated to non-wage distributions.

[kathyc2]

Another agreement with Kathy.

In my opinion, if sole employee/shareholder does all of the work and has minimal financial investment, then almost 100% of the profit should be wages. The more that other people do the work and/or the employee/shareholder had large financial investments into the business, the more that can be allocated to non-wage distributions.

199A further complicates the reasonable salary situation. A webinar I took this week pointed out that we may want to think long and hard about taking the full 199A deduction if the shareholder/employee does not take a reasonable salary.

[TaxGuyBill]

199A further complicates the reasonable salary situation. A webinar I took this week pointed out that we may want to think long and hard about taking the full 199A deduction if the shareholder/employee does not take a reasonable salary.

I sort of disagree with that. We should think long and hard about doing the tax return if the shareholder/employee does not take a reasonable salary.

If we are convinced the shareholder/employee is misreporting salary versus distributions, I don't think we should be preparing that tax return. The §199A deduction shouldn't have anything to do with it. On the flip side, if you are okay with filing the tax return with the salary versus distributions, the §199A deduction should be used. I would think it would be unethical to not give the full §199A deduction we are okay with filing the rest of the tax return.

[kathyc2]

I sort of disagree with that. We should think long and hard about doing the tax return if the shareholder/employee does not take a reasonable salary.

If we are convinced the shareholder/employee is misreporting salary versus distributions, I don't think we should be preparing that tax return. The §199A deduction shouldn't have anything to do with it. On the flip side, if you are okay with filing the tax return with the salary versus distributions, the §199A deduction should be used. I would think it would be unethical to not give the full §199A deduction we are okay with filing the rest of the tax return.

I think it depends a little on the circumstances. For years I prepared the personal return of a client who was an employee/shareholder in a 2 person S corp. Another firm prepared the S return, and the other shareholder was the one who took care of such things. My client had a W-2 of around 25K and an additional 50K or so of K1 income that was taken out as dividends. Every year I pointed out that he should be taking more as wages. If I were the one preparing the S return, I would have insisted they take more in wages or go elsewhere. The business was sold a couple of years ago, so the 199A will not be an issue. If the business was still open, I would need to think how to handle it to have it not reflect back to me. I think that is what the webinar was pointing out; situations where we prepare the 1040 but not the 1120S.

[TaxGuyBill]

I guess I still disagree. If I'm willing to accept that a W-2 with $25,000 and a K-1 with $50,000 is accurate, I would view it as unethical to not give the full §199A deduction. If I was NOT willing to accept that a W-2 with $25,000 and a K-1 with $50,000 is accurate, I wouldn't do the return unless they were corrected.