WorldWide Drilling Resource

Drilling Into Money Not Boring by Mark E. Battersby Reasonable Compensation Under TCJA To keep the owners of pass-through entities from underpaying taxes, last December’s Tax Cuts and Jobs Act (TCJA) required many drilling businesses to pay a “reasonable” amount of compensation for the service of their owners. Now, the Internal Revenue Service (IRS) is considering whether the reason- able compensation rules should apply to partnerships and sole proprietors. The new tax law included a 20% deduction from the income of pass-through businesses such as S Corporations, LLCs, partnerships, and sole proprietorships. However, the TCJA limited the deduction to what lawmakers call “qualifying business income,” amounts which do not include “reasonable compensation” paid by a pass-through business. The term “reasonable compensation” has a long history. For many years, the issue was whether the owner/employee of an incorporated drilling business was reasonably compensated for the services performed for his or her business. Since div- idends paid to shareholders can’t be deducted by an incorporated business, but compensation is, was the owner paying him- or herself more compensation than was reasonable? Too much or too little, the IRS has yet to provide guidance on how to determine the reasonableness of an owner’s salary. Congress’s watchdog, the U.S. Government Accountability Office, issued a study show- ing S Corporations had underreported shareholder compensation by nearly $25 billion over a two-year period - with those having three shareholders or less account- ing for the lion’s share of the underre- porting. The courts, for their part, weigh such factors as the compensation of nonowner employees, past salary history, industry formulas, and the financial condition of the business. However, despite the fact all these factors are considered, the con- sideration carrying the most weight with the courts appears to be “the replacement cost to the business of hiring an outside party to perform the owner’s duties.” Although lawmakers have again failed to define “reasonable,” the TCJA created a 20% deduction which applies to the first $315,000 of pass-through income (half that for single taxpayers). For pass-through income above these thresholds, the new law also allows the 20% deduction, but only for “business profits,” producing a tax bill at the owner’s top marginal tax rate of as much as 29.6%. The ongoing argument of what is “reasonable” compensation for those who own and operate pass-through business- es has increased in complexity thanks to the new pass-through income deduction. The need for professional assistance when determining - and supporting - the amount of compensation paid the oper- ation’s owners can’t be emphasized enough as the IRS is watching. Mark michele@ worldwidedrillingresource.com New & Used Equipment Elevators SkyRex We Support Our Troops! Stock Sizes: 1” thru 24” for casing, column pipe, tubing, and drill pipe. *Load test certificates available *Offered with or without base UsedWorldwide HD Elevators • Drill Pipe • Drill Collars • Manual Tongs • Spiders • RC Swivels We have elevators of all sizes, types, and weights; can build to any special applications. • Stabilizers • Bits • Bowls • Centrifugal Pumps • Crossover Subs Available with or without a base 12 MAY 2018 WorldWide Drilling Resource ®