If you take one thing from the S corporation half of Corporations Mastering, take this. Reasonable compensation is where the money is, where the exposure is, and where most preparers are guessing. Why the number exists An S corporation shareholder who works in the business is an employee. Wages carry FICA. Distributions do not. So there is a permanent incentive to call everything a distribution and nothing a wage, and the whole body of law here exists to push back on that. The rule is short. A shareholder who performs services must be paid reasonable compensation for those services, and the IRS can recharacterize distributions as wages when he is not. Rev. Rul. 74-44 said it in 1974 and the courts have been saying it ever since. What actually loses cases The cases that go badly for taxpayers are not close calls about whether $60,000 or $80,000 was reasonable. They are cases where the owner paid himself nothing, or something absurd, while pulling six figures out as distributions. - In Spicer Accounting, an accountant worked full time in his own firm, took no salary, and took distributions. The Ninth Circuit had no difficulty calling them wages. - In Joly, same pattern, same result. - In Watson, an accountant in a profitable firm paid himself $24,000 and distributed roughly $200,000. The court accepted the government's expert and moved a large slice into wages. Watson is the useful one, because the taxpayer was not paying zero. He was paying too little, and too little was enough to lose. How to actually set it There is no formula in the code and anyone who gives you a clean percentage is selling something. What defends the number is a documented process. The factors the courts keep using: 1. What the person actually does. Hours, role, whether he is the one generating the revenue. 2. Training, experience and credentials. 3. What the business would pay a stranger to do that job in that market. 4. What comparable businesses pay comparable people. 5. The company's own history and what it can afford. 6. How much of the profit is really from his labor and how much is from capital, employees or systems.

September 15 is the extended deadline for calendar year S corporations and partnerships. Which means this is the month people discover things. Here is one that comes up more than it should. The situation A two owner service company. Formed as an LLC in early 2024. Their lawyer told them to be an S corporation, their bookkeeper set up payroll, they ran W-2 wages for both owners, they filed a Form 1120-S for 2024 and another for 2025, and both years the K-1s flowed to their 1040s. New client walks in this September. I ask for the acceptance letter. Nobody has one. I pull the account. The IRS has no S election on file. Form 2553 was never sent. It was on the lawyer's checklist, the bookkeeper assumed the lawyer did it, the lawyer assumed the accountant did it. What they actually were A two member LLC with no election is a partnership. So for two years they filed the wrong return, on the wrong form, with the wrong owner compensation treatment, and paid payroll tax on wages that a partnership does not pay to its partners. Left alone this ends badly. The 1120-S filings get treated as unfiled 1120-S returns from an ineligible filer, the partnership returns were never filed at all, and the late filing penalty for a partnership return is $255 per partner per month for returns filed in 2026 and $260 for returns filed in 2027. Two partners, two years, twelve months capped. The exposure runs past $12,000 in penalties before anybody talks about tax. The fix Rev. Proc. 2013-30. It is the most useful revenue procedure a small practice can know, and it is not complicated. - It gives simplified relief for a late S election when the request is made within 3 years and 75 days of the intended effective date. They were inside that window by a comfortable margin. - The entity has to have intended to be an S corporation from that date, and has to have reported consistently as one. They had. Two 1120-S returns, two sets of K-1s, W-2 wages for both owners. Every piece of paper said S corporation. - It needs reasonable cause stated in the request. Not an excuse. A short factual explanation of what happened and why. - The Form 2553 gets filed with FILED PURSUANT TO REV. PROC. 2013-30 written across the top, with the statement of reasonable cause attached and every shareholder signing.

Almost every hour you lose in February was lost in your intake. Fix the front and the rest gets quiet. 1. One organizer, out in December. Same one for everybody. If you are asking each client different questions by memory, you are going to forget one on the client where it mattered. 2. Ask the life change questions up front. Married, divorced, new baby, moved states, bought a house, started a business, took money out of retirement, got a notice. Every one of those changes the return, and none of them come up on their own. 3. Define complete, then hold the line. Write down what a complete file is. Nothing starts until it is complete. Half started returns are what turn one job into four. 4. Collect identification once and store it properly. Encrypted, locked, and with a real answer for who can see it. You are holding the most valuable thing your client owns. 5. Text messages are not a document system. Documents come through the portal. Once you allow one exception you have twelve clients sending you blurry photos at eleven at night and no record of what you received. 6. Send an engagement letter and get it signed. What you are doing, what you are not doing, what it costs, and what happens if they give you bad information. It is the cheapest protection you will ever buy. 7. Set the turnaround in writing before you start. When you will have it, how they hear from you, and what happens if something is missing. Almost every angry call is really a call about an expectation nobody set. None of this is glamorous. All of it buys back your February. General information for tax professionals, not advice on any one client's facts. Figures move. Check the current ones with the IRS before you rely on them. CG6LLC