At the recent NACVA conference in New Orleans, former IRS manager Michael Gregory (Michael Gregory Consulting LLC) did a session on the recently released IRS job aid on reasonable compensation. Gregory worked on the job aid while he was with the agency.
Practice tips: The IRS uses three sources of data—Watson Wyatt, RMA’s Annual Statement Studies, and the Economic Research Institute (ERI)—when examining reasonable compensation, but ERI is used only for classification purposes, not for bottom-line numbers, according to Gregory. In examining compensation issues, the IRS looks at ratios for red flags, he points out. For example, if a company is operating in the 25th percentile and its compensation is in the 90th percentile, the IRS is likely to “take a look.” Also, if compensation reported by a pass-through entity drops materially (without a corresponding drop in financial performance), the IRS will take note but will typically not take any action. However, if this continues in a second year, an audit could be triggered if the IRS feels the company is trying to avoid payroll taxes.
Gregory will conduct a webinar on the IRS job aid on August 4. He also has a new book, How the IRS Determines Reasonable Compensation with Job Aid Commentary by the Original IRS Champion. The IRS job aid is available from BVR as a free download.