HearthRC Defense intake: Accounting and CPA firms
The defense is the documentation, not the number.
A shareholder-employee performing more than minor services must be paid reasonable compensation before distributions (IRC §3121(d)(1); Rev. Rul. 74-44). When the salary is too low, the IRS can recharacterize distributions as wages and assess back payroll taxes. The controlling case, Watson v. United States (8th Cir. 2012), endorsed valuing the owner's services task by task, and IRS Fact Sheet FS-2008-25 lists the nine factors examiners weigh.
There is no safe harbor and no statutory percentage. What holds up is documentation: who does what, for how many hours, valued against the right labor markets. This intake gathers the facts that documentation is built from.
1.Entity and compliance baseline
The election, the ownership, and the pay pattern examiners look at first.
S election effective date
From Form 2553. Note any late-election relief in the notes below.
State of formation
State registration and ownership rules
Licensed CPA firm registration, and whether a majority-CPA-ownership rule applies under state accountancy law.
Ownership
All shareholders. Note anyone who does not materially participate.
| Shareholder | Ownership % | Materially participates? |
|---|---|---|
W-2 wages vs distributions, last three years
| Tax year | Owner W-2 wages | Distributions |
|---|---|---|
| Two years back | ||
| Last year | ||
| Current year |
Payroll cadence
Lump-sum timing is factor 6 in FS-2008-25 and a common examination trigger.
Distributions proportionate to ownership?
Disproportionate distributions risk the single class of stock rule.
Anything else on the entity
Late-election relief, mid-year ownership changes, related entities.
2.Owner profile
Credentials, history, and role shape which labor markets apply to the owner's time.
Credentials
CPA, EA, and other designations: CGMA, CFP, CVA, ABV, CFE.
Years licensed and years as owner or partner
Include states of licensure.
Practice concentration
Tax, audit and assurance, advisory or client accounting services, bookkeeping, forensic.
Management education
MBA, MST, or formal firm-management training.
Agreements tied to the owner
Operating or partnership agreement terms, buy-in, any non-compete with the entity (factor 8).
3.Time and function allocation
The core of the analysis. Allocate the owner's hours across roles; each role benchmarks against its own labor market. If no time log exists, a representative two-week log is worth requesting.
Hours per week by role
Wage benchmarks shown are the Bureau of Labor Statistics occupation codes each role maps to.
| Role | Hrs / wk | Notes |
|---|---|---|
| Client service, billable (tax, audit, advisory) | ||
| Managing partner and firm operations | ||
| Business development and origination | ||
| Bookkeeping, data entry, reconciliations | ||
| Front office, scheduling, client intake | ||
| HR, hiring, staff supervision and review | ||
| CEO level: strategy, banking, technology | ||
Total hours per week (hrs)
Weeks worked per year (weeks)
Locations
Accounting and CPA firms: worth knowing
- Owner billable hours are the floor, not the ceiling. BLS accountant medians reflect employees; a partner doing senior review and complex advisory is valued above staff realization rates before management time is added.
4.Business financials, three years
Three years back where available. Net income before owner compensation is the anchor figure.
Revenue and net income
| Tax year | Gross revenue | Net income before owner comp |
|---|---|---|
| Two years back | ||
| Last year | ||
| Current year |
Revenue by service line
Tax, audit and assurance, advisory or CAS, bookkeeping. Three years where available.
Billable hours, realization, utilization
Owner billable hours, realization and utilization rates, work in process.
Tax season share
Share of revenue and owner hours falling in January through April.
Offices, headcount, leverage
Number of offices, staff headcount, and staff per owner.
Assets and capital in the entity
Fixed assets, technology, equipment, and any real estate held inside or outside the entity.
AAA and distribution history
Accumulated Adjustments Account balance and the distribution pattern (factor 4).
Accounting and CPA firms: worth knowing
- Firms often pay owners a spring lump sum after tax season. That is the same year-end timing examiners flag under factor 6; ratable payroll through the year is cleaner to defend.
- As a practice shifts from compliance toward advisory and CAS, the owner's role looks more like a financial manager, which raises the benchmark.
5.Internal comparables
The biggest exposure in most engagements. When a hired employee doing part of the owner's job out-earns the owner's W-2, the number is hard to defend regardless of the report. Build the owner's wage from what it costs to replace each function.
Staff wages and hours
W-2 wages and hours for staff whose work overlaps the owner's roles.
| Person or role | Annual W-2 wages | Hrs / wk | Pay structure |
|---|---|---|---|
Benefits and extras
Bonuses, benefits, continuing-education stipends, license or dues reimbursement.
1099 contractors
Contract staff or agents doing owner-type work, and their rates.
Accounting and CPA firms: worth knowing
- If a staff CPA earns $85K and the owner takes $45K, the number is indefensible regardless of any report. Anchor the owner's billable component at or above the firm's own senior and manager wages, then layer management and origination value on top.
6.Market data sources
Which benchmark sources the engagement will draw on. Geography matters: metro-level wage data can swing a figure 15 to 25 percent.
Sources in scope
Sources already in hand
Anything the firm has already pulled or subscribes to.
Accounting and CPA firms: worth knowing
- May 2024 BLS median for Accountants and Auditors (13-2011): $81,680. That reflects employees, not owners. Treat it as the floor for the owner's billable hours, then layer management and origination value.
7.Documentation and supporting records
What exists today. Missing items are normal at intake; the engagement produces several of them.
Already on hand
Where the records live
Payroll provider, document system, or the person who has them.