Whoa, Nelly!

A lot of you (whether or not you are my clients) are going to get a load of …. from your tax advisors from now on.   Because there seems to be no end to the potential penalties the IRS can impose on tax professionals- due to the failure of his/her clients!

I have often written about the need to ensure that companies provide reasonable compensation  (RC) to their stockholder/owner/employees.  [Here’s but one example.] And, the determination of those figures almost always involved consternation on the part of clients.

Well, let me explain to you why your advisor  (if they are truly competent) have to do so.  Because there are penalties that the IRS will impose upon tax professionals who fail to determine that the compensation listed on the tax return is proper.  (That’s separate from the penalties and interest- and taxes- to be paid by the improperly paid executive and the firm.)  In at least one case, the penalty imposed upon the practitioner was $ 5000.  Moreover, the situation (the penalty and determination) is a public record, so the practitioner will have to do a lot of explaining to the other clients.  Notwithstanding that the IRS now has a pool of companies (his/her other clients) to discern if reasonable compensation is provided by them.

The case in point gets even better.  It seems that the tax practitioner recognized that the client was underpaying.  So, the practitioner developed a plan to bring the compensation into line over the course of four years.  The IRS challenged the compensation- but by the time of the audit, the compensation was only slightly out of line.  So, the firm’s adjustment was a small amount.  But, the practitioner was fined the $ 5K for participating in this sham.  (OK.  After a few years of complaints, the practitioner finally got the penalty removed- but at the expense of hours of negotiation with the IRS and a much damaged reputation.)

According to the IRS, it is the function of the tax advisor to explain to S entity owner/executives (the firms are called pass-through entities, since the profits pass through to the owners) the fallacy of not providing reasonable compensation.  We- the tax professionals- are required to ask appropriate questions and obtain documentation to assure ourselves (and the IRS) that the entity is paying an RC. Yes, the IRS expects that tax professionals will not just accept the information proffered by the client, but ascertain the reasonableness and completeness of the data against a checklist we develop.  And, the failure to obtain such answers is an actionable offense according to the IRS.

This is why folks like me always demand information that can at least discern if RC is being provided.  And, why we get angry when folks seem to space off our requests. Because we are responsible to keep the documentation in our records.  (I just reminded one client yesterday that a failure to respond is NOT an acceptable situation.  I, for one, assume such failure to mean that the worst case is to be expected and act as if that obtains.  Which usually means a much larger tax bill is due to be paid.)

Caveat consiliaris.   (That means: advisor beware.   Caveat emptor means buyer beware.)

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