Reasonable comp services

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#1
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Tis the season for entity planning.

I have a handful of clients that we're setting up S Corps for in queue. I'd like to offer a reasonable comp study as an alternative to the quick but not-so accurate method of the client just playing around on job posting websites. My plan is to use RCReports.com, so there will be input and carrying cost for me.

For those of you who offer this service, what's the average amount of input time? What do you charge as a fee, if you don't mind me asking?
 

#2
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Bumping this.

In order to make this work and be profitable for me, I'm considering charging around $1,000 for each reasonable comp engagement. Maybe a bulk discount for multiple employees. e.g. If a two man S Corp wants reports done for each owner, I'll charge $1,750 (maybe).

I believe that may make certain clients balk, but I think I can sell it based on what the alternatives are, and there's no way it'll be profitable at a lesser rate like $500 per engagement based on getting the engagement letter in place and all of the back and forth.
 

#3
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I think you can only sell it if you believe that the RC Reports figure is going to come in significantly below the number you have in your head. For instance, if I have a plumber who owns 100% of his S Corp and has 2 employees, an assistant and a bookkeeper. Let's say he grosses $735k in revenue and has a net profit of $350k before we factor in any salary for himself.

In my mind, I put his salary at $125k and he reports net income of $225k. If the RC Reports shows his reasonable salary should be $78,774 then the study is saving him $7,000 + per year. If the RC Reports consistently come in below what your top of the head number is then it is a no brainer.

The problem is a reasonable comp study is not required and I would dare say 99.9% of S Corps and CPA's do not utilize them. We have been doing S Corps for 35 years since the 1986 tax law changes and I have never talked to a CPA that uses them or even seen one. If the RC Reports is always higher than your number, then it becomes a much harder sell. Using my example, what happens if they say the plumber needs to be paid $288,444 ? You are basically charging your client for something not needed and costing him money and others will be willing to point this out.

My guess is RC Reports is way more agressive than me or 95% of CPA's. And their numbers will be shockingly low to most and if that allows you to set the low salary it is a good service to offer
 

#4
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BerkshireCPA wrote:If the RC Reports is always higher than your number, then it becomes a much harder sell. Using my example, what happens if they say the plumber needs to be paid $288,444 ? You are basically charging your client for something not needed and costing him money and others will be willing to point this out.


To play the devil's advocate, in that example isn't the value to the client that you've substantially mitigated risk of reclassification of distributions to wages and all the back taxes, penalty and interest that come along with that? Further, if that fact pattern is true there's no way he should be an S Corp.

It's my personal opinion that RCReports is much more accurate and a higher level of substantiation than job posting websites. And setting reasonable comp as a rough percentage of net taxable income before owner payments is the most spotty.

How are you coming up with your reasonable comp figures?
 

#5
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I look at RC Reports like I do the R&D tax credit firms and the Cost Segregation firms. They have experts that are going to back up their positions but most CPA's (and maybe clients) are not looking to take that added risk.

I doubt RC Reports would have many customers if they were overly cautious. Instead they are probably the opposite. And honestly, I never looked at them in that light.
 

#6
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Sorry, what do you mean "I look at RC Reports"? Could you expand? Do they have a database you look at?
 

#7
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No I do not view their reports. When I say I look at ... I mean I view them as the same way I view the specialized companies that offer R&D Tax tax services or Cost Segregation Studies to CPA firms. They specialize in this area and are a lot more aggressive in the positions that they take.
 

#8
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We come up with our reasonable comp figures the way I assume most CPA firms do, through our years of experience. We have been around 60 plus years and have had dozens and dozens of S Corp audits and have seen tens of thousands of tax returns. I have never seen reasonable comp as an issue. But all of our S Corp clients are taking salaries so we do not worry

Maybe if someone is relatively new to the tax business and have not seen a lot of S Corps, then maybe they would like an outsider input. But how much time do you think the Biden's CPA took dealing with the reasonable comp issue in 2018? Probably less than 5 minutes
 

#9
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I'm curious to understand why you would think an extremely profitable contractor should NOT be an S Corp. What would you suggest?
 

#10
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If reasonable comp truly is $288,444 on net income before owner payments of $350,000 as you used in your example, I think there's a strong possibility that the cost-benefit of an S Corp is negligible or even negative.

I think what it comes down to is that I'm not willing to absorb the risk of using a rule of thumb based on experience. Part of that may be lack of experience and comfort, part of it may be that the IRS intends to start cracking down on S Corp reasonable comp issues. So, what I'll do is give the client the option to determine and set their own reasonable comp after explaining what reasonable comp is and the associated exposure if reasonable comp is not paid, or, I'll offer a reasonable comp engagement in which I lean on RCReports. I'm going to set it at $750 until I have more data points regarding the time investment on my end.
 

#11
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Ok, I would agree that if the IRS expected us to pay salaries of $288k then it would be hardly worthwhile. But i do not think anyone would ever think the IRS would ever make that argument.

I would love to hear from someone that actually does use the service and give us a feel for what their numbers look like.
 

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BerkshireCPA wrote:Ok, I would agree that if the IRS expected us to pay salaries of $288k then it would be hardly worthwhile. But i do not think anyone would ever think the IRS would ever make that argument.


The case law is always amusing to me on this because the IRS's definition of reasonable compensation is usually lower than what we as accountant's believe it should be. It Watson v Commissioner, Watson took a $24,000 salary compared to $203,000 in income distributions. The court found that his salary should be $91,000. I really don't see anybody ready to jump on board being a partner of a CPA firm for a 90K salary. Managers make more than that, but that was also 20 years ago. Case in point, a large majority of CPA's with their thinking would rush to put Watson on $130,000 salary or more and cause him to pay 5K+ more in taxes just going off of "experience" or "feeling" compared to using a service like RC Reports.
 

#13
ATSMAN  
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>>> We come up with our reasonable comp figures the way I assume most CPA firms do, through our years of experience.
I agree with that. I have not used RC reports BUT I have used the various online resources and calculators to come up with what both I and my client could agree and defend if we have to. I only had one situation where the owner did NOT agree with me and fortunately we parted ways.
 

#14
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100% agree with what Warnick is saying, I think most tax pros are conservative. I could be wrong but when I have read through all of these reasonable comp threads through the years, I believe most assumed that if you were using a service like RC Reports then you were being even more conservative. But now that I look at their website and think about it, in reality you would use a service like RC Reports to justify an even lower salary.

The AICPA just came out with another of their compensation surveys. I believe the average partner compensation for a firm with over $2 million in revenue was like $561,000. Does anyone think those firms are saying we will use that as a guide for reasonable comp?
 

#15
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I will not calculate reasonable comp for clients unless it is via RCReports because they have far more information at their disposal than I do. It takes some time to properly identify and enter the information to then create the report. You also need to be careful about the actual titles or roles assigned and hours spent on each.

I charge $1750 or so for an RCReport utilizing cost approach. My experience is their wages are generally lower than what clients arrive at and so it offers tremendous benefit while having very detailed information IF the reasonable comp is challenged by IRS.

One of my clients decided they did not want to pay me so much for three reasonable comp reports. They are obtaining it through some MBA program they're involved with, so I am going to be incredibly curious to see the reports, detail, and if they look reasonable to me or not.
 

#16
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Cornerstone

Can you give us a feel or sample of what RC Reports numbers look like? Would you say that they are 50% or 100% below your initial thought.
 

#17
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I'd also be interested in your average time investment per engagement.

Do you allow the client to fill out their own information in the cost approach? Or do you interview them or provide an organizer, and complete the information for them?
 

#18
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I've done both--they can fill it in online, or I go over questions with them. To get it right requires at least 6 hours of involvement between me and each shareholder. People are way too quick to choose various titles that really inflate the reasonable comp, so I make them do some critical thinking because they also over or underestimate time spent on various functions. Most fail to realize just how much time they spend on admin topics until they really sit down and think about it.

As to how much lower RCReports tends to be, for an MD client I believe their reasonable comp came back around $240k and they pay themselves close to $280k by choice. Mine came back about 20% lower than I actually pay myself via W2 wages. Again, by choice...more factors to look at than simply IRS compliance.
 

#19
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There are a lot of very vocal CPAs that say a formal study is needed, but I'd agree most do not. And I question how necessary this study is. In my mind, unless a shareholder is taking $24,000 with $200,000 in distributions (I don't need a study to tell me that's wrong), or the study would provide documentation for taking a much lower salary than the client thinks is necessary to save on payroll taxes, I fail to see the value in these studies.

BerkshireCPA wrote:The problem is a reasonable comp study is not required and I would dare say 99.9% of S Corps and CPA's do not utilize them. We have been doing S Corps for 35 years since the 1986 tax law changes and I have never talked to a CPA that uses them or even seen one. You are basically charging your client for something not needed and costing him money and others will be willing to point this out.


6 HOURS? Wow. What is the process that takes so long? That can't be for a single shareholder, is it?

CornerstoneCPA wrote:I've done both--they can fill it in online, or I go over questions with them. To get it right requires at least 6 hours of involvement between me and each shareholder.



If that is true for a CPA firm partner, why not just get most clients closer to $90,000 and call it a day?

warnickcpa wrote:The case law is always amusing to me on this because the IRS's definition of reasonable compensation is usually lower than what we as accountant's believe it should be. It Watson v Commissioner, Watson took a $24,000 salary compared to $203,000 in income distributions. The court found that his salary should be $91,000.
 

#20
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smtcpa wrote:
6 HOURS? Wow. What is the process that takes so long? That can't be for a single shareholder, is it?


That's average per shareholder in my experience, especially given most clients I have worked with on it are not interested in it and become very lazy, which can be counterproductive to an accurate report. If you use RCReports and depending on how involved the client chooses to be, it can require a lot of time. There are a lot of questions, job functions, etc., to review, really think about in terms of ACTUAL functions, assigning hours to each function, etc.

If a client asks me what they should pay themselves, I will not give out a figure without a formal study. If they tell me a figure and it seems reasonable in my head, all I say is "OK, just make sure you have support if challenged by IRS."

A solo CPA does a lot of admin work, so reasonable comp is going to be lower than one that is a partner and overseeing an entire office or division for a region. Or a medical doctor that has a tremendous amount of paperwork to complete relative to their active shifts. But then if that MD hires out their accounting and tax matters to a CPA, for example, then it is going to increase the reasonable comp because less time is spent on admin functions.
 

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