If you already are thinking about the long days and endless compliance headaches of the coming tax season, it is time to shift your mindset and put a stop to the cycle of tax season burnout and stress before you have no choice but to face it again.
How, you might ask? It starts by expanding the potential of your firm’s revenue stream to recognize the opportunities in every tax client engagement to create a win-win solution and elevate your role as a trusted advisor to your clients.
If you serve S-Corp clients, who must calculate a salary to pay themselves, or any other business owners who are also on their own payroll, you have the perfect segue into leveraging reasonable compensation calculations to create additional revenue opportunities by advising them in this area.
Reasonable compensation reports help you go beyond the limits of seasonal tax clients.
It is critical to understand that reasonable compensation is so much more than just a method for determining compensation for business owners.
In fact it affects everything from payroll taxes, tax planning strategies, entity selection, Social Security Insurance, disability income and more.
It is also important to start with a clear understanding of how accurate reasonable compensation calculations and reporting can help you transition away from a heavily compliance-based practice to one that offers much more value (and is compensated accordingly).
Let’s take a look at some definitions of reasonable compensation so you can start advising your clients on this critical component of their business taxes and planning.
Reasonable compensation is something that many CPAs, EA’s, tax professionals, and business advisors learn about in college and continuing education. But it is a sorely misunderstood topic and the calculations are even more of a mysterious mess for many business owners.
Here are three of the more popular definitions of reasonable compensation:
- IRS Code: Section 162-7(b)(3) states — Reasonable compensation is the value that would ordinarily be paid for services by like enterprises under similar circumstances.
- Valuation — The hypothetical replacement cost of an owner or key manager of a business.
- As a question — How much compensation would be paid for this same position, held by a non-owner in an arm's-length employment relationship, at a similar company?
Now we need to simplify the basics. If you just read the definitions above to your clients, they will either feign understanding or look at you with blank stares. To simplify:
1. Replacement Cost — If you had to go out into your community and hire someone to replace yourself and perform all the services and tasks that you perform, what would you have to pay them?
2. Fair Market Value — If you were to close your business, and go across town and work for a competitor performing the same services and tasks for your competitor that you currently perform, what would the competitor pay you (FMV) for those same services?
RC Reports' Paul Hamann takes a deep dive into another approach your firm can use to drive profits. Sign up for the Nov. 30 'Future Forward Virtual Conference' webinar HERE.
Be ready for pushback. Here are the two most common objections that arise when explaining reasonable compensation to a business owner:
- What’s the end game? Believe it or not, some business owners attempt to drive their reasonable compensation up or down for some perceived benefit.
- But I’m awesome. When a business owner incorporates their ego into their reasonable compensation, it will likely be anything but “reasonable.”
Use your expertise in the area of reasonable comp, along with the tools provided in RCReports, to help overcome these objections.
If your clients try to drive their reasonable compensation number up or down—understand why so you can best advise them on how to achieve their goals. It also is your job to help them understand the negative implications of artificially inflating or deflating their reasonable comp figure—which will save them in the long run and help you expand your tax compliance engagements into advisory relationships that will provide ongoing revenue beyond this coming tax season.
Paul Hamann is founder and President of RCReports, an online application that determines Reasonable Compensation for Closely-Held Business owners. The software is used by tax and financial advisors when they need to determine a Reasonable Compensation figure for a client.
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