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Unreasonable compensation.

The payment of an "excessive" amount to an employee for services rendered is considered to be unreasonable compensation. Whether compensation is excessive, and therefore unreasonable, is often determined by reference to payments by similar corporations to employees performing like services. The problem is most often encountered with regard to employee-stockholders, where a salary would be a deductible business expense to the businesses, but a dividend would be nondeductible.

Underlying any discussion of employee benefits is the assumption that, if challenged by the Internal Revenue Service, the increased compensation could be shown to be reasonable. Compensation includes not only money, but also payments "in kind." For example, all of the following are considered compensation: the personal use of an automobile, lodging for the employee's family while on vacation, premiums for group term insurance, medical expense reimbursements, premiums paid under an executive equity plan, and the value of life insurance protection under an endorsement split-dollar plan. It should be noted that no deduction is allowed for compensation that is paid to certain highly compensated officers of publicly-held corporations in excess of $1,000,000 (see discussion on page 435).

However, it appears to be the experience of many accountants and tax advisors that the threat of a successful challenge by the Service is more imagined than real. This may often be due to a belated recognition by the courts, as well as the Service, that the business owner spent many years being underpaid while the business grew, and now has the "right" to compensation for those earlier services. After all, it was the owner who made the small closely-held business a success, and sooner or later he should be paid for his efforts. However, the determination depends on the circumstances of each situation.

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Title Annotation:Terms & Concepts
Publication:Field Guide to Estate, Employee, & Business Planning
Date:Jan 1, 2010
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