Preventing A Challenge To (Un)Reasonable Compensation- CPAs Can Help Clients Stave Off IRS Scrutiny With A Little Foresight

As the IRS increases scrutiny of executive compensation, CPAs need to proactively advise their clients on how to withstand these inquiries. As a result of IRS training initiatives, three types of entities draw the most attention and therefore need good advice from CPAs.

(1) closely-held C corporations are examined to determine whether they have overpaid their shareholder-employees. These corporations are allowed to deduct only “reasonable” compensation paid to shareholder-employees. So, examiners are looking for a disguised dividend, which is corporate profit being treated as compensation. Since a dividend is not deductible, but compensation is, the IRS may treat the portion of the compensation that it considers excessive as a dividend. The result is that the corporation loses its deduction for that amount and is assessed tax, interest, and penalties on the resulting increase in income.

(2) S corporations are audited to determine whether they have underpaid their shareholder-employees. These shareholders may have set their own pay levels unreasonably low and simultaneously increased their profit distributions. Since compensation is subject to payroll taxes, but distributions are not, some tax savings can Read More